On Wednesday this week the Federal Reserve Open Market Committee lowered its primary interest rate by one quarter of one percent to a range of 1.50% to 1.75%. The move was widely anticipated, and traders who make bets on such things had assigned a 100% probability of this policy change going into the Fed meetings this week.
This is the third interest rate cut this year, following four rate increases in 2018, and returns rates back to June 2018 levels, unwinding the fall rate increases from last year that many market commentators felt drove the fourth quarter stock market decline of nearly 20%.
Accompanying the announcement of the rate cut was language indicating no immediate future rate cuts should be expected this year, but also language implying that the central bank would be very cautious about raising interest rates anytime soon as well.
So, it seems for now at least, it's steady as it goes on interest rates here in the U.S. Stock investors seemed to like this approach as stocks traded nicely higher immediately following the Fed’s post meeting comments, further extending recent record highs in stock prices.
With unemployment at 3.5% and third quarter GDP growth coming in at 1.9%, which was stronger than anticipated, I find myself wondering if another rate cut was justified. As the current trend of economic growth and stock market expansion gets longer and longer in the tooth, I find myself concerned that potential asset price bubbles are more likely to occur.
In my experience, the secret sauce to most asset bubbles tends to be low interest rates, and the Fed has now made it pretty clear it will continue to keep the cost of money low, making borrowing money to purchase assets and drive prices higher more affordable and so therefore probable.
As I’ve mentioned before, I am committed to watching the world to help keep readers apprised of asset price issues I perceive as problematic. While U.S. stocks are certainly not cheap by most reasonable measures, they don’t seem tremendously overvalued either.
Stocks in developed foreign markets such as Europe and Japan have actually been cheap by most metrics for a decade or more, and commenting on emerging market stocks is beyond the scope of this column and not likely to impact most U.S. investors anyways.
Bonds and interest rates certainly reflect unusual pricing, and I’m sure many market prognosticators will continue to raise red flags over a supposed bubble in bonds. In my opinion, however, a bubble in bond prices based on interest rates represents less potential danger to typical investors, than a bubble based on weaker bond credits (junk bonds) or more opaque financial instruments such as asset backed securities. As long as the major banks are not over exposed to credit risk or complex instruments which led to the 2008 crisis, it’s hard for me to lose sleep over bond prices being too high. And right now, bank balance sheets are stronger than they have ever been during my investing career.
Sure, the world has more debt today than any time in history (Institute of International Finance), but with super low interest rates now for over a decade, I would have been surprised if this wasn’t the case.
Now, interestingly, with the ongoing drama associated with the Wework implosion, perhaps we are seeing a correction in private equity investments in the U.S. If you haven’t followed this absurd story, I suggest you “google” it for a nice smirk, but private equity is not likely to impact typical retirement investors and people saving for college, and I believe it tends to work itself out on its own without a lot of contagion.
If I’m seeming a little blasé about this week’s rate cut, I am. I’m enjoying the rally in to stocks, but am committed to not getting too excited as we push through new highs. We might be in a “goldilocks” moment, but you won’t find me forgetting the Papa Bear always eventually comes home.