On the eve of what looks like our first rate cut in a decade, I hear a lot of chatter on how this will benefit U.S. growth prospects via lower interest rates on loans and mortgages.  Well, being the curious fella I am, I decided to take a look at a couple things.

First, since consumers are big borrowers, and are typically more rate sensitive than businesses tend to be historically, I chose to look at how consumer confidence responded to interest rate cuts.  As you can see in the chart below, interstingly, not very well.



It would appear interest rate reductions actually have a negative effect on consumer confidence (red lines mark first cut).  There was one instance where several aggressive cuts by the Fed did not initially hurt consumer confidence and that was in 1998.  That was when we were in the throws of the Long Term Capital Management blow-up and the Russian debt crisis.  So what kept confidence rising?  My guess is we were in a stock market bubble that kept consumers' wealth rising rapidly, which in turn, kept consumers confident until the bubble popped, and the Fed began aggressive rate cuts in early 2000.

So, why is this important to bankers?   The next chart highlights the importance.  There is a strong correlation between consumer confidence and total loans and lease growth.  We need to watch what happens if/when the Fed actually cuts rates.  If the Fed needs to start a new easing cycle, and the stock market responds in a negative fashion, it is likely consumers will quickly become less confident, and thus a slowdown in loan and lease growth can be anticipated.  If the Fed is just going to cut rates once or twice, and stocks resume their bubbly advance, we could see a continuation of the current loan growth we are experiencing.



As always, there is no certainty in any of this.  However, those who ignore history are doomed to repeat it. 

In my last post, I pointed out the manufacturing sector was in the midst of slowing.  Evidence is starting to mount that the slowdown is starting to spread to different sectors of our economy.  

First, let's look at the volume of goods moving through our economy via ground transportation.  The chart below shows the year-over-year (YOY) percentage change in the Cass Freight Index.  June marks the 7th consecutive month of declines in this very important economic indicator. 
 



The next sector I want to highlight is housing.  New building permits are an important indication of future housing activity.  Housing activity also affects virtually every aspect of overall US economic activity.  June marks the 6th consecutive month of declines, on a YOY% change basis, in this indicator.  



Neither of these sectors say we are currently in a recession.  They do however confirm the slowdown in US economic activity is not only here, but spreading throughout important economic sectors.  I will be keenly focused on employment growth as we move through the rest of the year.  This sector's health will ultimately determine, both how aggressive the Fed gets with interest rate reductions, and whether the US economy can avoid a recession in 2020.
 

In my last post on March 1^st, I noted the growth slowdown my weekly model had projected, had arrived.  In the chart below,  you see various regional purchasing managers’ indexes (PMI) for their respective manufacturing area.  They appear to be confirming the slowdown is here as well. So, now that we are in the midst of slowing economic activity, what does it mean for community bankers?? 



The second chart idicates that according to the bond market, growth going forward is likely to remain a concern.  The chart is the visual of a probit model developed by the NY Federal Reserve.  It was built to analyze the term structure of Treasury yields, and based on their structure (i.e. inverted), calculate the probability of experiencing a recession within the next 12 months.  As you can see, we crossed a historically important line four months ago.  Since 1968, whenever the probability exceeded the red line, we have fallen into a recession within 12 months. Does this mean a recession is certain?  Well, no.  Nothing is certain but death and taxes.  However, this cannot be ignored because it implies two very important future events for bankers: falling short interest rates and a rising unemployment rate (think credit risk). 



If we extend the look-back period to 1953 on the NY Fed probit model, in October 1966, the model showed a high probability of entering a recession but a recession never came.  Why?  Because the Fed cut short rates aggressively in November 1966 and the unemployment rate remained low and stable as the Fed continued to ease rates into 1967.   



We are in a very similar situation today.  The odds of recession next summer are high, but if the unemployment rate remains low and stable AND the Fed begins to ease monetary policy aggressively, then we could see a growth slowdown rather than an outright recession in 2020.  The Fed funds futures are pricing in a 100% chance of a 25 bps rate cut and a 33% chance of a 50 bps rate cut at the July meeting.  They are also pricing in a 1.50% Fed funds rate by mid-2020. 


 
Regardless of how the future unfolds, I believe the evidence is overwhelming at this point.  The market is urging you to prepare your balance sheet (think cash flow) for a falling rate environment for the foreseeable future.