The Dow Jones and the broader U.S. stock market were in solid form in the first half of 2019 despite geopolitical tensions on several fronts. The Dow and the S&P 500 hit new highs a week ago thanks to the Federal Reserve’s dovish monetary policy outlook.
But former White House communications director Anthony “The Mooch” Scaramucci believes that the Fed doesn’t have reason to be dovish anymore.
In an interview with Fox Business, Scaramucci said:
“I don’t think the Fed can cut rates here, given how strong the economy is.”
The Mooch has a point
Famous for being the shortest White House communications director with an official tenure of just six days, Scaramucci is making a valid point about the Fed’s stance on interest rates.
The latest jobs data for June indicates that the state of the economy is strong. Nonfarm payrolls increased by 224,000 last month, blasting past the original expectation of 165,000 job additions. What’s more, wage growth came in at 3.1%, a hair lower than the 3.2% forecast.
But the positive jobs report spells bad news for the stock market. The chart at the beginning clearly shows that the Dow has started trending lower, and the jobs report has added to the downward pressure by reducing the scope of a rate cut. Scaramucci added:
“If he cuts rates, it is going to be very, very good for the stock market, but I’m just worried that it may be too early to start that process, given the strength of the economy. Remember, he only has got 250 basis points. And you need about 400 basis points of stimulus … to smooth out the sharp edges of a recession. And so he doesn’t have a lot of bullets in the tank.”
Bad news for the Dow and the broader stock market
Lower interest rates bode well for the stock market and the Dow. That’s because the cost of borrowing reduces in a low interest-rate scenario, giving companies the required ammunition to boost capital expenses, expand their business, and deliver fatter profits.
This is why a drop in the probability of a rate cut by the Fed hurts the stock market and the Dow.
Cleveland Fed President Loretta Mester said last week that going for a rate cut right now would be premature, and the Fed should wait for more inputs before taking a decision. She said (as reported by CNBC):
“At the present time, I believe it is too soon to make that determination, and I prefer to gather more information before considering a change in our monetary policy stance.”
But stock market watchers believe that the Fed could still go for a rate cut this month as an “insurance” against global economic and political tensions as well as weak U.S. manufacturing data. Last month, the IHS Markit manufacturing index was down to 50.1, the lowest level the index has seen in a decade.
The ISM manufacturing index also fell to its lowest level since the end of 2016 to 51.7. Though a reading above 50 indicates expansion in manufacturing activity, the problem over here is that the index has been sliding for a year now.
So the market is still hoping for a rate cut this month in view of the broader market data. But if that doesn’t arrive and Scaramucci’s prediction is true, the Dow and the broader US stock market could take a beating in the second half of 2019.