Fed keeps the money flowing, but real economy showing warning signs

To no surprise, the the Federal Reserve left interest rates unchanged today.

The Fed said it would keep lending to the short-term money market via short-term repo operations through April. Previously, it said the program would last through mid-February. The monthly purchases of T-bills will also last through April.

Some analysts have been calling the balance sheet policy “QE” or quantitative easing.

The rate-setting Federal Open Market Committee cut interest rates three times in 2019, in policy moves characterized as insurance cuts, to shield the U.S. economy from damages tied to the U.S. trade war with China. The economy has stabilized since the rate cuts, and has also been helped by a partial trade pact this month with China that eases some tensions between the global economic superpowers.

The central bank’s description of the economy was unchanged from six weeks ago: the labor market remained strong, growth was helped by consumer spending, and inflation remained below the 2% target.

As a result, the bank voted unanimously kept its benchmark fed-funds rate steady in a range between 1.5% and 1.75%.

Well, the labor markets and consumer spending are OK for now, but they’re also not growing at the levels we had this time last year, even with the drop in interest rates.

And the bond markets have been telling an interesting story in the last couple of weeks, as long-term rates have dropped while the shortest-term rates have remained the same.

While we’re not back to the 2-year/10-year inversion that freaked out Wall Street last Fall, but we’re a lot closer to it than we were a month ago, with the gap nearly being cut in half from the end of December.

Dec 31, 2019
2-year note 1.58
10-year note 1.92%
GAP 0.34%

Jan 29, 2020
2-year note 1.42% (-0.16%)
10-year note 1.60% (-0.32%)
GAP 0.18%

And there was another item that came out today that seems to give some warning signs of a slowing economy. It was the Philadelphia Fed's coincident index of the economies of all 50 states. The good news for us is that these reports show Wisconsin is out of its mid-2019 decline and has resumed growing (slowly), but other states aren't so lucky.

That's still a large majority of states growing over the last 3 months. But it also is an increasing number of states falling into the red and gray shades. So much so that a stat called the "diffusion index", which compares the number of states increasing vs declining, is now at the lowest levels in nearly 10 years.

As you can see 3 of the last 4 times that this index has gotten this low after the economy had been growing for a few years, recession followed within a year. The only "false positive" was in the middle of 1995, right around the time that the Internet was starting to become integrated into business operations.

Not saying recession is imminent, but there are definitely signals that our currently maxed-out economy isn't going to get better. And given that the manufacturing figures for December showed further weakening in that sector, let's keep an eye on this as 2020 moves along.