History Shows the Fed Would Be Cutting Rates by Now

The federal courthouse in Martinsburg, W.Va. (Kevin Fogarty/Reuters)

Commentary 

It is a study in confoundingly sharp contrasts. On the one side, last week the U.S. Bureau of Economic Analysis (BEA) “shocked” the media, anyway, by releasing its estimate for U.S. real GDP during 2022’s first three months. Disaster. Negative. A sickly economy already showing signs of the demand destruction markets have been pricing for quite some time.

This week, it’s over on the other side of perception where the Federal Reserve takes sharp focus. Having hiked its suite of interest rate benchmarks back in March for the first time in recent years, the Fed did so again though this time at double the rate. A somewhat cautious earlier 25 basis point hike is now followed up with a fifty and only expectations for more of the latter.

Thus, the disparity; twice the rate for rate hikes is intended to really stomp the brakes on rampaging consumer prices by, in theory, slowing down the U.S. economy, when, as noted above, that same U.S. economy just posted an outright contraction in total output.

What seems to be a conundrum, to borrow a term: isn’t it already slow, if not too slow?

According to those at the Federal Reserve, there is no inconsistency for them to explain. Yes, real GDP declined during Q1 but the econometric models used by officials tell them the reverse was, dare I write, transitory. A bunch of quirky results wrapped in a blanket of nothing-to-see-here, those at the Fed aren’t deterred by the BEA’s reported ugliness.

As they see things, consumer prices rather than recession remain the real risk to Americans.

Markets aren’t buying the denial, nor this official balance. Rather than consist of a single quarter of concerning results for a single economic statistic, there is a growing catalog of disquieting numbers actually consistent with how most markets—including stocks!—are pricing the near-term future.

One complete set of those numbers was also released this week to go along with last week’s GDP study. The Institute of Supply Management (ISM) has for decades been surveying purchasing managers, preparing the results of those surveys, and publishing how those might figure the contemporary situation. This is the grand-daddy of PMIs, the gold standard for estimates about economic sentiment.

According to it, the US economy has already descended into territory more closely aligned with past rate cuts by the Fed rather than hikes. In each of its two separate PMIs, one focused on strictly domestic manufacturing, the other oriented toward America’s service sector businesses, the implications are really just that simple.

The first of those, manufacturing, dropped to 55.4 for April 2022, down from 57.1 in March. The other, non-manufacturing, its headline index declined from 58.3 to 57.1.

A number above 50 for most PMIs including these cited here indicates generally more expansion than contraction in the economy. So, what’s the big deal with both well above that level?

These don’t represent one-month declines, both continue an already-substantial and prolonged downward slide—especially in their forward-looking New Orders components. Even if still above 50, in the past this kind of slide had triggered a sharp turnaround in monetary policymakers’ thinking and action.

Just a few years ago, in 2019, the same Federal Reserve which had been hiking its benchmark rates for the same reasons as today abruptly halted them. As economic data like the ISM continued to get worse, by July of that year Fed Chairman Jay Powell’s group completely reversed course when confronted by such clear evidence of broad-based economic weakness rather than the expected higher levels of inflation and economic activity.

These sentiment estimates do correlate closely enough with the BEA’s GDP figures over time, too. In other words, weak data isn’t an isolated case pictured exclusively by the ISM’s set of PMIs. On the contrary, those corroborate what the BEA had been reporting for quite some time.

That wasn’t just a single quarter of contraction. The full range of GDP estimates actually show, unsurprisingly, the same thing the ISM does. Two out of the previous three quarterly GDP rates have been particularly worrisome, obviously including the most recent negative, but even the last of those merely hid the same problems under a torrent of inventory (shown below).

Accounting for inventory, it’s not one quarter of bad GDP, rather three in a row. The same is even more evident across the rest of the underlying BEA data, economic accounts such as final sales which only measures actual sales of goods and services to end users. The last nine months of Final Sales of Domestic Product merely punctuate what’s been previously observed.

Beyond strictly economic statistics, the U.S. dollar’s continued and now accelerated sharp rise is that much more convincing. Over the past quarter-century, whenever the dollar goes higher in exchange value against a wide array of counterparty currencies, the entire global economy almost always suffers an agonizing reverse.

This was true, again, during that same 2018-19 Federal Reserve reversal. The dollar shot higher in the early months of 2018 which was consistent with the growing evidence (like the ISMs) of global economic decline while at the same time Jay Powell’s group ignored it, like the conflicting data, and continued to raise their rates anticipating only higher inflation.

From the start of 2019, the dollar would linger upward as the global economy slid toward recession (pre-COVID), and then that Fed policy U-turn.

Pretty near everything in 2022—except the CPI—is screaming economic trouble just ahead; and it’s not of the inflationary variety. Whether sentiment like the ISM numbers, real GDP (and not just the latest quarterly minus), and especially the blatantly disconcerting skyrocketing dollar, it all adds up to what normally would have convinced those at the hapless Federal Reserve to start cutting by now.

Interestingly enough, the last time any Fed had raised its rates by this latest amount, fifty, it was May of 2000 when Alan Greenspan feared, as always, an outbreak of genuine inflation which markets did not. That hike would prove to be the last one Greenspan would get, as the dot-com recession, not more inflation, would begin just nine months later.

What was the ISM’s Manufacturing PMI doing in May 2000? It was at 54.7—not far off from last month’s 55.4—well off its earlier high and sliding further down on its way toward that 2001 recessionary abyss.