Monthly Insights: June 2019

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Will the Fed Help Sustain the Expansion?

Imagine a world where global economic growth is slowing, trade barriers are impinging economic activity, and equity markets are falling. The pièce de résistance is a precipitous decline in confidence. It’s certainly not a pleasant picture, but that’s exactly the picture Jerome Powell, Chairman of the Federal Reserve, painted in his latest speech. The risks are real, but Powell’s assertion that the Fed will “act as appropriate to sustain the expansion” was music to investors’ears, recently sending U.S. stock markets to the strongest day in nearly half a year.

Once again, this looks like a case of bad news being good news. In other words, weaker economic growth is okay because the Fed is there to backstop the economy. Frankly, the short-term impact is just noise (although strong days in the market do feel good!). However, the long-term implication of a flexible Federal Reserve is significant. As such, Chairman Powell’s recent comments warrant further attention. After all, history shows the Federal Reserve usually acts too late to bring the punch bowl back to the party. Why would this time be any different?

For starters, under current economic conditions the Federal Reserve has flexibility. The Fed usually raises interest rates because economic growth is so strong that inflation rises. This time around, that was not the case. Instead, the U.S. has experienced slow economic growth and muted inflation consistently below the Fed’s target. This time the Fed raised interest rates to attempt to normalize monetary policy, not because there was a specific economic need for higher rates. It is a very important distinction. Current conditions give the Fed the ability to move on the fly, adjust interest rates lower if growth slows, while not worrying about runaway inflation. 

This fundamental monetary policy evolution is not only happening in the U.S., but around the globe. For decades, pricing power stability dominated central bank policies. Now, economic growth stability dominates the conversation. There are many reasons for this, but a big part of the explanation is changing demographics. Aging populations suppress inflation pressures. Without strong inflation central banks are free to focus more of their attention managing growth. In many ways this is supportive of longer, more stable economic expansions as opposed to the big boom and bust cycles of the past. 

That’s not to say that this scenario will play out exactly as expected. Most likely it won’t. However, the mere fact that Chairman Powell spoke about it gives investors confidence that the Federal Reserve will operate flexible monetary policy if the economy warrants. In other words, the Federal Reserve put option is alive and well. In the meantime, Allegiant’s Economic Dashboard has one yellow and one red indicator. Although economic growth is slowing, the data does not yet signal any major changes.

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Benjamin W. Jones, CFP®, AIF®
President, Chief Investment Officer, Principal