How Effective Will The Fed’s 0.25% Cut Will Be In 2019

The Fed’s rate cut at the end of July generated mixed reactions. Some economists say its too low, and some are saying the 0.25% cut is enough to stimulate the economy. Many analysts have predicted a downturn at the start of 2020. What are the conditions pointing to a coming downturn? Will the rate cut will be able to push it back?

There are many signals that show a fast impending downturn. Amongst the most obvious and trustworthy are increasing inflation and credit card payment delinquency.

Increasing inflation is the most obvious and trustworthy signal that indicates an approaching downturn. Inflation itself can contribute to a recession (when consumers don’t have the financial means to buy more expensive products).

However, the process of increasing inflation can be far more harmful than the effects of increased prices of goods and services. Most businesses are operating in a way to keep the costs of their products as low as possible. When businesses are unable to “eat” the higher production costs, they pass them onto consumers. The increase in inflation in USA (from 0.2% in July 2018 to 0.4% in March 2019), then can signal that more and more businesses are in a financially precarious position. Moreover, any turn for the negative could cause the businesses to downsize their operations or even to shut them down.

Coupled with decreasing demand for goods and services, increasing inflation in USA becomes a much larger problem.

US is the centre of the world’s financial services industry, and health of this industry is a reliable indicator of the health of the US economy. The increasing credit card delinquency rates, from 2.15 to 2.59 percent in just 3 years, show an economy not strong enough to cope with debt commitments.

Less trustworthy, but still important signals about a fast approaching downturn are decreasing borrowing numbers and declining unemployment.

The declining percentage of unemployed workers can be interpreted as one of the signs of a downturn. Declining unemployment seems like a counter-intuitive way of predicting a downturn. However, when the employment figures reach near full employment, the statistics show a warning.

The wide labour slack, shows that the labour resources aren’t being utilized efficiently enough. The slack in USA has been widening with only marginal improvements. This means that the utilization of labour resources isn’t becoming more efficient, hence creating an economy where many workers are in potentially financially dangerous situation.

Borrowing numbers in USA have been growing at a slower rate since 2015. The less households borrow, the smaller the confidence about their financial future, and the ability to pay back loans on time. A glaring warning related to borrowing rates comes from the timing of their decline.

From another perspective, lower borrowing rates can be indicative of a more financially conscious society. Or, more households earn enough income, and don’t need to open more or larger credit lines.

Harder competition in the labour market has also contributed to a society where many look for ways to save or budget money.

Of course, more money being saved or budgeted won’t always lead to lower borrowing rates or even a long term decline in household spending. A major fluctuation in the short term does not always transfer to a large change in the long term.

The current decline in borrowing rates and the increasing labour slack could mean that an increasing share of Americans aren’t confident about their financial future. With the statistics to back up these convictions, it’s not hard to say that the current economic condition strongly suggests a coming downturn.

How effective this rate cut will be at pushing it back? It will depend on several conditions.

The quarter percent rate cut won’t push back an economic downturn if more actions directed to change the structural basis of the American economy won’t be taken.

US has long been a services economy (80% contribution to GDP in 2017). Yet, its manufacturing and agriculture sectors still produce more than 19% of GDP.

The decline of these sectors will make the US far more vulnerable to the cyclical nature of the business cycle. The domination of services sector in the share of contribution to GDP, makes both the economy and the workers more vulnerable to fluctuations of downturns and growth.

Many services businesses produce non-necessity services, or services whose consumption can be easily reduced because of lower consumer incomes. This makes the economy far more dependent on the trends in income and the financial state of consumers. And because the majority of workers in US are employed in the services industry, their financial livelihoods are also disproportionately impacted by this state.

The worldwide movement of manufacturing into low labour cost countries did not spare USA. Although attempts have been made to bring back manufacturing to USA, more work is needed. For better or worse, the only path for the manufacturing in developed countries seems to be niche specialisation and highly technical production.

The rate cut of the Federal Reserve should stimulate the economy, and create better financial conditions to businesses. The positive outcomes of the cut for businesses will touch these sectors. Nevertheless, without promoting technical, rather than labour intensive production, the positive outcomes won’t make a big difference.

The Fed’s rate cut should make an impact on fallen mortgage numbers in USA. The American mortgage numbers have been growing at a slower rate since the third quarter of 2018. This has happened alongside with earlier discussed slower growth in borrowing numbers. Historically, the rate cuts (e.g. in 2001 and 2002) have been implemented to, and have helped to fight coming recessions. There’s a strong precedent for this rate cut to stimulate economic activity in 2019.

A real estate mortgage is likely to be the largest financial commitment in a person’s life. If mortgage growth numbers are decreasing, without a decrease in wages, it could point to declining consumer confidence in the economy or their own financial state. However, that doesn’t seem to be the case in USA.

The 0.25% cut will lead to a decrease in prime lending rates. With an increase in consumer confidence (11.4 points from June to July), the declining lending rates should push back a downturn for around a year, if not more.

Will higher mortgage rates provide enough stimulus for the economy to continue the longest-ever bull run? There’s a small probability of that happening.

Even worse, if the outputs, along with exports will continue to fall in 2020, even another rate cut won’t be able to stimulate the economy. Increasing indebtedness and lower business revenues separately aren’t big problems, but together they spell trouble for the American economy.

It will take more than a year to see the negative impact of increasing indebtedness through credit card delinquency and declining business incomes. But that negative impact will come. It’s not unrealistic to predict that lower business incomes will lead to lower worker salaries, lay-offs, or even more outsourcing.

Bigger indebtedness creates an economy more vulnerable to any negative trends. And sooner or later, the same indebted individuals or businesses will feel the impact of lower incomes or revenues. This situation will be far more difficult to manage, compared to a stimulation of the economy through a rate cut.

The rate cut theoretically could push business to expand their operations by the use of cheaper loans. Better credit rates for new business also will be an impact of this rate cut. This can theoretically lead to more new business being opened. That would undoubtedly benefit the American economy.

In practice, the probability of all these benefits materializing because of a rate cut is low. One of the preferred choices of raising funding still continues to be family and friends. For the startup-minded, venture or crowd funding is the way to raise initial capital. A quarter percent cut makes business loans more attractive, but only marginally.

The end of the longest bull run is bound to be harsh on the consumers and the investors. With the consumers and businesses being accustomed to growing incomes and revenues, facing a downturn will be difficult both financially and emotionally.

The conditions pointing to a downturn aren’t strong in the current environment. Yet, they could become if any current USA’s economic and trade problems will worsen in the near future. The rate cut, even if it benefits some of the participants in the economy, won’t solve the far bigger problems related to other stakeholders. If more efforts to implement structural changes will follow along with the rate cut, then it could be a powerful measure to prolong the bull run. Without them, the rate cut will be far less powerful than it could be.