U.S. Markets close in 2 hrs 59 mins

The Fed Has Crossed the Interest Rate Rubicon

Last month, the Federal Reserve made the fateful choice to cut interest rates for the first time since December 2008. With the trade war between the United States and China heating up, as well as domestic economic data looking increasingly dicey, the prospects of a global downturn have been mounting. Thus, it is understandable that Fed Chair Jerome Powell might opt to ease rates in an effort to keep the economy ticking along. Understandable, but highly questionable.

Investors have very good cause to be worried about the Fed's latest action.

Caught in the spotlight

As we have opined previously, no one wants to be blamed for causing a recession. Of course, the whole point of an apolitical central bank is that its leaders are not susceptible to political pressure, nor to bending to short-term desires to prop up asset bubbles. But the Fed chair is not a faceless economist. He is a public figure and, as much as he might want to portray himself as a dispassionate public servant, he has his own incentives to keep the economy moving along, even if a correction is what the doctor ordered.

It is quite clear at this point that Powell would rather keep the music going for as long as possible, hopefully to the end of his term at the helm of the Fed. Once he is out the door, the economy becomes someone else's problem. One need only look at the behavior of his predecessor, Janet Yellen, whose frequent market and economic commentary has kept her in the public eye, but with none of the responsibility to grapple with the hard decisions that now face Powell.

Central banks are supposed to use interest rate adjustments to moderate the business cycle, raising rates to cool off rampant expansion and overexuberance and cutting them when the economy slides toward recession. This is certainly the conventional wisdom, and what most central bankers say they are supposed to be doing. But it is definitely not what Powell has been doing.

A strange mid-cycle

Even though the economy has had its longest-ever expansion, and the stock market has had its longest-ever bull run, Powell seems to now think we are only in the middle of the economic cycle:

"We're thinking of it essentially as a midcycle adjustment to policy... [We] think it will serve all of those goals...That refers back to other times when the FOMC has cut rates in the middle of a cycle and I'm contrasting it there with the beginning of a lengthy cutting cycle. That is not what we're seeing now, that's not our perspective now."

Powell has decided that discretion is the better part of valor, opting to reverse his once hawkish interest rate posture. Far better to let someone else take the blame for an economic downturn, whether it is good economic policy or not. Investing legend Howard Marks (Trades, Portfolio) has opined on the strangeness of this decision:

"The process of lowering the rates causes assets to inflate. There will be more wealth piled up by the people who have assets and it'll be harder for people who just have a little bit of savings to make a return...We generally don't stimulate the economy after ten good years. We usually accept that there will be an ebb and flow to the cycle and there might be justified recession."

Voices of dissent

Like Marks, we find it difficult to comprehend how exactly the current economy could be considered "midcycle" by any sensible definition of an economic cycle. Evidently, we are far from alone in our incredulity, as evidenced by a rare voice of dissent from within the Federal Open Market Committee.

Eric Rosengren, the president of the Boston Fed, was not enthused by the decision to lower rates. He took the rare move of voting against the majority of his compatriots on the committee as well as offering a public justification for his dissent:

"With the unemployment rate near 50-year lows and inflation likely to rise toward the 2 percent target, and with financial stability concerns being somewhat elevated given near-record equity prices and corporate leverage, I do not see a clear and compelling case for additional monetary accommodation at this time."

In for a penny

When a central bank bows to political pressure once, it inevitably increases the prospect that it will happen again. Despite the many public calls in recent days by former Fed officials to respect the independence of the agency, President Donald Trump has continued his efforts to pressure the central bank into further rate cuts. After the rate cut was announced, Trump took to Twitter, demanding more Fed action to bolster domestic businesses, including manufacturers like Caterpillar Inc. (NYSE:CAT) and carmakers like General Motors (NYSE:GM) and Ford Motor Corp. (NYSE:F):

"As your President, one would think that I would be thrilled with our very strong dollar. I am not! The Fed's high interest rate level, in comparison to other countries, is keeping the dollar high, making it more difficult for our great manufacturers like Caterpillar, Boeing, John Deere, our car companies, & others, to compete on a level playing field. With substantial Fed Cuts (there is no inflation) and no quantitative tightening, the dollar will make it possible for our companies to win against any competition. We have the greatest companies in the world, there is nobody even close, but unfortunately the same cannot be said about our Federal Reserve. They have called it wrong at every step of the way, and we are still winning. Can you imagine what would happen if they actually called it right?"

Powell has bowed to political pressure already, so it is unsurprising that the market now expects further capitulation in future. Indeed, Goldman Sachs (NYSE:GS) now expects even more rate cuts in response to the escalating trade war.

The die is cast

Alas, for all the talk of an apolitical Fed, Powell's leadership has proven very susceptible to political pressure. Moreover, the central bank boss clearly wants to protect his own reputation and legacy.

It is hard to put the priorities of the economy as a whole over one's own interests. While we expect that from our central bankers, it is clear that, in practice, they are still just as human as the rest of us. Perhaps the greatest tragedy is the Fed's actions will likely do little to ameliorate even the proximate effects of the expanding economic troubles, especially the trade war. In a recent interview, Bankrate.com senior economic analyst Mark Hamrick made that very point:

"The Fed cannot stop the bleeding by placing an interest-cut bandaid on trade tensions."

Investors should not make decisions based on the assumption that the Federal Reserve will act in apolitical, data-driven ways. The Fed appears increasingly politicized, and that is not likely to change even after Trump leaves office. As a result, long-term, value-oriented investors should act with the understanding that monetary policy may not be as stable -- or reliable -- in the future.

Disclosure: No positions.

Read more here:

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

This article first appeared on GuruFocus.