The interest rate cut announced by the Federal Reserve on July 31, 2019 may fail to re-energize the economy and support the stock market, warns Barry Bannister, head of institutional equity strategy at Stifel Nicolaus & Co., Business Insider reports. He observes that the Fed had raised rates to levels similar to those before the last three market crises, and that it may be too late for a rate cut to avert the next disaster.

"Cutting twice and having neutral rise slightly only returns you to a fairly tight level that existed in the summer of 1998, 2000, and 2007, which you'll see is before difficulties in the market," Bannister told BI. It would be a "terrible policy mistake" that sends the market tumbling if the Fed does not cut rates again, and soon, he insists.

Significance for Investors

Bannister fears that borrowing costs may be perilously close to the so-called neutral interest rate at which the economy is stable, neither growing nor contracting. Many informed observers, among them both Fed Chair Jerome Powell and Bannister, believe that the neutral rate has dropped in recent decades as the result of falling labor productivity and negative demographic trends, such as an aging population.

In other words, over time, lower interest rates have been needed to keep the economy and stock prices on an even keel. While there is no consensus on what the neutral rate is now, Bannister estimates it to be roughly 2.3%. The Fed's announcement on July 31, 2019 lowered its target range for the benchmark federal funds rate by 25 basis points (bp) to between 2.00% and 2.25%.

Rob Arnott, founder of asset management firm Research Associates and best-known as a developer of smart beta investing strategies, agrees on the need for faster rate cuts. “If the Fed waits, they’ll be so far behind the curve they can’t do a darned thing,” Arnott told Barron's. “The National Bureau of Economic Research announces recessions often six to 12 months after they’ve started. If you wait six to 12 months, you’re too late,” he added. 

The contrasting view is that the Fed already has created dangerous asset bubbles by pushing interest rates down to historic lows over the past decade. These critics see a different troubling parallel with 1998, when the Fed cut interest rates to stabilize the markets after Russia defaulted on its sovereign debt and hedge fund Long Term Capital Management (LTCM) collapsed. The ultimate effect was to enlarge the dotcom bubble that ended in a market crash, a column in Barron's notes.

Back in 1998, the economy was solid and in no need of monetary stimulus, a situation that also holds today, that column argues. Indeed, U.S. real GDP grew at a solid 2.1% annualized rate in 2Q 2019, though down from 3.1% in 1Q 2019, another Barron's column observes. Moreover, consumer spending, which is about 70% of GDP, grew at a brisk 4.3% annualized rate in 2Q 2019, up sharply from 0.8% in 1Q 2019, the column adds.

Looking Ahead

"We think that they'll [the Fed] err on the side of caution and cut both July 31st and in September," Bannister told BI. "However, it might require some market weakness and data weakness in the month of August, as well as trade disruptions, to cause the Fed to go ahead with the September cut which we think is necessary," he added.