Barkin asks what signal the bond market is sending

Bonds

Federal Reserve Bank of Richmond President Tom Barkin said he’s weighing pessimism in the the bond market against other economic signals to evaluate whether cutting interest rates is an effective response.

“Overall, I think it’s safe to say the economy is giving us conflicting signals,” Barkin said in prepared text released by the Fed. While consumers and labor market indicators suggest rates should be held or raised, “the softness of investment, inflation and the bond market might be saying ‘lower rates.’”

Federal Reserve Bank of Richmond President Tom Barkin

While consumers fuel the economy, business investment has been weak, Barkin said, asking how further softening will affect the economy. He raised concern whether, in an increasingly global economy, a recession could spread to the U.S., rather than spread from the U.S., as is traditionally the case.

With the bond market pessimistic and the stock market buoyant, “Experience says the bond market wins — but is the bond market sending us the same signals it used to when rates are so low?” Barkin asked.

“Turning to monetary policy, uncertainty can also dampen the impact we might expect from any policy ‘stance,’” Barkin said. “Accommodative monetary policy stimulates the economy. But in the presence of high uncertainty — nearly all of which is generated by forces extraneous to what the [Federal Open Market Committee] does — we risk not getting the same ‘bang for the buck.’ The stimulus to borrow could be outweighed by perceived risks to future cash flow.”

And, he added, “high uncertainty scrambles the signals. Financial markets are being moved by trade these days rather than by our policy stance.”

Whether the uncertainty is short-term or long-term matters. “If the current uncertainty is temporary, then the right course of action is to see through it the way we might see through movements in the more volatile components of inflation,” Barkin said. “The divergence we see between strong consumption and weaker investment may well be signaling that the uncertainty won’t persist. The recent headway made on trade negotiations may lessen our downside, as might the progress being made in the Brexit negotiations.”

However, if the uncertainty lingers, “we’ll have to recognize that even though we have tools to use, they’re potentially less effective. For that reason, I’m closely monitoring whether the recent ‘insurance’ the FOMC purchased will have its intended effect.”

“His comments reflect the reality that in the face of uncertainty — whether economic, business, or both — that reducing interest rates can only do so much,” according to Greg McBride, chief financial analyst at Bankrate.com. “Lower rates don’t completely offset the uncertainty and that uncertainty will keep nervous businesses from borrowing, investing, or hiring.”

Barkin doesn’t expect a recession, unless a shock happens, even though risks “are tilted to the downside.”

“As long as consumers keep spending, we will be in a good place,” he said.

Consumers
Separately, the Federal Reserve Bank of Dallas looked at the “divergence” between the Conference Board’s consumer confidence index and the University of Michigan’s consumer sentiment index.

While confidence is high, sentiment fell to its lowest level since 2016.

“Divergence between these two measures is typical late in the business cycle,” according to the report’s authors Alexander W. Richter, a senior research economist at the Dallas Fed, and Tyler Atkinson, a business economist with the Dallas Fed.

“The current gap between the two consumer surveys is signaling that the labor market is tight but has stopped becoming tighter,” they write. “This is consistent with many other indicators, such as the unemployment rate and gross domestic product growth.”

They suggest the indicators show a recession is not “inevitable but that growth is likely slowing.”

Trade deficit
The U.S. trade deficit narrowed to a five-month low of $52.5 billion in September from $55.0 billion in August.

Economists polled by IFR expected the $52.5 billion deficit.

ISM non-manufacturing index
The Institute for Supply Management’s non-manufacturing index rose to 54.7 in October from 52.6 in September.

Economists expected a 53.4 read.

“The index (above 50) suggests that the non-manufacturing sector, which accounts for the majority of U.S. economic activity, continues to expand and should lead to continued increases in U.S. real GDP,” Berenberg Capital Markets U.S. Economist Roiana Reid wrote in a note.

The survey was “softer than suggested by the headline index: 13 non-manufacturing industries reported growth, the lower end of its recent range, and six of the 10 subindexes declined.”

Respondents’ comments offered positive views on the outlook and spending, with concern about labor shortages, trade and tariffs, she said.


Gary Siegel

Gary Siegel

Gary Siegel has been at The Bond Buyer since 1989, currently covering economic indicators and the Federal Reserve system.

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