Stock sell-off spotlights Fed’s role in the economy – and the election
Last week, Federal Reserve Chair Jerome Powell suggested the central bank would finally cut interest rates in September. Investors have been wanting to see such a pivot. But is it coming too late? On Friday, the Labor Department reported the United States added far fewer jobs in July than expected. Major stock indexes have been falling since then.
Cries of recession are going up. But not everyone is buying it. “A weak July employment report does not a recession make,” Ed Yardeni and Eric Wallerstein of Yardeni Research Inc. wrote in a Monday note. In fact, some analysts expect stocks to rally after the November election.
Why We Wrote This
The Federal Reserve is signaling a cut in interest rates to sustain economic growth. The timing means some will call the move politically motivated, even though central bankers say they act independently of politics.
Some analysts say a rate cut so close to the election opens the central bank to Republican charges that it is favoring Democrats, though the Fed has either raised or lowered rates in 10 of the last 11 election seasons.
And a rate cut isn’t guaranteed to help the incumbent party in the White House. Just ask former President Donald Trump. Pandemic rate cuts buoyed the economy in 2020, but not in time to help Mr. Trump, who lost the election.
In an ideal world, central bankers meet on Mount Olympus, setting policy without regard to the political or market gyrations raging below them. In America, they meet in Washington.
And they meet even in election years.
Political and market pressures are inevitable, especially in a political campaign season in which U.S. monetary policy is nearing an inflection point. Events in the past few days have reinforced just how intense those pressures can be and why, politically and economically, the Federal Reserve is so important.
Why We Wrote This
The Federal Reserve is signaling a cut in interest rates to sustain economic growth. The timing means some will call the move politically motivated, even though central bankers say they act independently of politics.
At a press conference last Wednesday, Fed Chair Jerome Powell strongly suggested that the central bank would finally cut interest rates in September. That’s what Wall Street has been waiting months to hear. Instead of rejoicing, traders appear worried the Fed has fallen behind a cooling economy. They initiated a sharp sell-off that is still reverberating around the world.
Chair Powell also went out of his way to reemphasize the Fed’s political independence. He was perhaps reacting to a recent published interview in which Donald Trump, the Republican nominee for president, said a September rate cut would be a mistake.
“Congress has, we believe, ordered us to conduct our business in a nonpolitical way at all times,” Mr. Powell said. “We never use our tools to support or oppose a political party, a politician, or any political outcome.”
Why stock prices falter: The reason may not be recession
The scrutiny of Fed moves – or even potential moves – is so intense because the Fed is so powerful. Its interest rate decisions help determine the direction of the economy. When the Fed raises interest rates, borrowing becomes more expensive and fewer businesses take out loans to expand. The economy tends to slow. Conversely, when the central bank lowers rates, the economy tends to accelerate.
The current stock swoon has many drivers. One is worry by investors that the immediate benefits of artificial intelligence are overhyped. Another is the recent hike in Japanese interest rates, which hurt Japan’s multinationals and killed a weird trade in which investors borrowed Japanese yen to buy stocks in other countries. But the bigger fear may be that the United States will tip into recession.
For months now, the economy has been showing signs of weakness. Many U.S. companies have reported gloomy outlooks for future sales. On Friday, the Labor Department reported the U.S. added 114,000 jobs in July, only about two-thirds of what many economists had been expecting.
Stock markets, which had already fallen Thursday on artificial intelligence fears and weak earnings reports, plunged. By the end of trading Friday, the tech-heavy Nasdaq composite index had fallen into what Wall Street calls “correction” territory. That means a fall of at least 10% from a recent high and one that marks the halfway point to a bear market. Foreign stock markets also felt the chill. By Monday, Japan’s Topix index had lost 12% of its value over three days, its biggest such plunge since at least 1959.
The losses intensified on all the major U.S. stock indexes Monday, with the Dow Jones Industrial Average losing more than 1,000 points, its largest single-day drop in nearly two years.
How much will the Fed cut interest rates?
Not everyone is buying the doom and gloom. “A weak July employment report does not a recession make,” Ed Yardeni and Eric Wallerstein of Yardeni Research Inc., an investment strategy firm, wrote in a Monday note. If things break right, the analysts wrote, they expect stocks to rally after the November election.
“The labor market is cooling, but without a sharp slowdown,” wrote analysts at Bank of America Securities. The jobs report likely looked worse because of Hurricane Beryl’s impact on the Texas labor market last month, they added.
The next question is what the Fed will do at its next meeting in September. Many analysts say the poor labor report guarantees a quarter-point cut in the Fed lending rate that influences wider interest rates. Some say the Fed will cut rates by a more dramatic half a percentage point.
A rate cut would make borrowing less expensive and help to boost the economy over time. Such a move, so close to the election, would open the Fed to Republican charges that it was tipping the scales in favor of the Democrats. At the same time, the Fed has never been shy about fiddling with interest rates in election years. It has either raised or lowered them in 10 of the last 11 elections. (The exception is 2012, when President Barack Obama was seeking reelection.)
The political fallout from such changes can be dramatic. The Fed reacted too late to pandemic-era inflation, and prices kept soaring. Many voters have not forgiven the administration for the 20% surge in the cost of living since Joe Biden took office.
By cutting rates, the central bank would signal that it has won the fight against inflation and can now turn its attention to boosting the economy. In theory, that could help Democratic presidential nominee Kamala Harris distance herself from the inflation under President Biden and push the idea that lower mortgage rates and better times lie ahead. The danger is that she could end up trying to sell half a seesaw to voters.
The flip side of a rate cut is that it usually signals a weakening economy, which typically hurts incumbents. Just ask former President Trump. When the pandemic threw millions of Americans out of work in 2020, the Fed scrambled to cut interest rates to counteract a short – but sharp – recession. It buoyed the economy but not in time to help Mr. Trump, who lost the election.
