The following commentary is from the September 15th issue of my Short Sellers Journal. For more information on this bear newsletter follow this link:  Short Sellers Journal Information

“The US economy is in a good place and our decision today is designed to keep it there.” – Jay Powell at his post-FOMC press conference

Here’s the opening sentence to the latest FOMC policy statement: “Recent indicators suggest that economic activity has continued to expand at a solid pace.” Think about it for a moment: why does the Fed need to cut rates at all given that the alleged unemployment rate is low relative to history, the stock market is at a record high and housing prices are at all-time highs? As the global head of Deutsche Bank’s economic research (Jim Reid) wrote: “the interest rate cut of a half-percentage-point to kick off its easing cycle looks harder to justify than those in 2001 and 2007.” I qualify that by saying “at least on the surface.”

The Fed only cuts 50 basis points at the start of a rate cut cycle as it did in 2001 and 2007 after there’s been a severe deterioration in the markets or the economy. We know the economy is not expanding at a “solid pace,” unless the Fed’s definition of “solid” is the opposite of the dictionary definition. Manufacturing has been in a recession for well over a year, the Dallas Fed Manufacturing index has been negative for 22 consecutive months. Housing hit a wall in May/June and homebuilders have slowed down the rate of housing starts by quite a bit. If it weren’t for a record level of Government deficit spending, the economy would be in a severe recession.

I’ve always maintained that you need to watch what the Fed does, not what it says. If the economy were “in a good place” the Fed would not have needed to start a rate-cut cycle with a 50 basis point cut. In fact, given that the Fed has access to better data than the public, it’s likely that the economy is in worse shape than is discernible from the private sector reports.

We know the Government economic data is manipulated to belie reality by reflecting stronger economic activity and lower inflation than is otherwise factual. During the post-FOMC meeting presser, Powell used the word “recalibration” in reference to the Fed’s level of policy rate being out of sync with the lower inflation rates and rising unemployment. As Rabobank ranted: “Powell had trouble clearly explaining the reason for the large cut because he did not want to admit that the ‘recalibration’ was needed because the FOMC had fallen behind the curve.”

Furthermore, it’s likely that the big bank balance sheets, along with the regional banks, are in worse shape than can be determined with publicly available data. The Fed has been slowly pumping reserves into the banking system since October 2023, which why M2 has risen by $364 billion since October 2023. That number is likely larger now as there’s a two-month lag in the data (the latest number is through the end of July).

The bottom line is that the economy is in trouble both with respect to the declining level of economic activity and the overall level of debt at every level of the economy – public, corporate and house-hold. Furthermore, an increasing percentage of that debt is becoming distressed.

With respect to that latter point, the Government Accountability Office (GAO) estimates that about 10 million borrowers – or 25% – of student loans are behind on payments as of the end of January. About two-thirds of them were more than three months behind. These borrowers are currently protected by a one-year moratorium ordered by the Biden administration that expires next month. There’s currently $1.6 trillion in outstanding student loan debt. The Biden Government has already forced taxpayers to eat $168.5 billion by forgiving it. Of course, that puts more stress on the record spending deficit.