Lowering interest rates is rooted in desperation. Watch out, investors

Editor’s Note: Sven Henrich is founder and lead market strategist at NorthmanTrader. The views expressed in this commentary are his own.

The Federal Reserve looks ready to cut interest rates, again. Investors, watch out.

While rate cuts, low interest rates and central bank intervention have been kind to asset prices over the past 10 years, a rate cut this month may eventually be bad news.

On Wednesday, markets reached new all-time highs minutes after Fed Chairman Jerome Powell delivered prepared remarks to Congress that low inflation, trade tensions and concerns about global growth have been weighing on the economic outlook. As a result, Powell said, the central bank will “act as appropriate” to sustain the current economic expansion.

Translation: The Fed will likely cut rates at its July meeting.

Markets immediately embraced the anticipated rate cut, but ignored the Fed chair’s underlying message: At the end of the longest economic expansion in history, not only is the US economy slowing, but so is the global economy.

So why are we experiencing new market highs? It’s not because of revenue and earnings growth. Quite the opposite — earnings growth is flat to negative. The global growth picture is regressive. US key indicators like durable goods and construction spending are also showing negative growth. Even employment growth is slowing, which typically happens at the end of a period of economic expansion.

These data trends reflect the warning signs coming from the bond market. The US 10-year treasury note has collapsed 40% since its peak in November.

None of these are signs of a healthy, expanding economy.

No, markets have been making new highs because both the Fed and the European Central Bank are desperate to extend the business cycle by any means necessary. But lowering rates is rooted in desperation, and investors may want to carefully consider history and context.

Consider that most of what central bankers have promised over the past 10 years has turned out to be wrong. Promised growth has never materialized. In fact, this longest expansion in history is also the weakest. And it comes at a very steep price. The United States has 105% debt to GDP, the highest corporate debt ever and the most extreme wealth inequality since the Great Depression. This is all courtesy of artificially low rates which have enabled debt expansion and directly inflated the assets typically owned by the top 1%.

And now, following the recent tax cuts, the United States is running trillion-dollar deficits again, and debt expansion subsidized by cheap money is holding up the entire economy.

The Fed hasn’t been meeting its 2% inflation target. Last year’s grand promises of rate hikes for 2019 and a Fed balance sheet normalization have run afoul. For 30 years, we’ve seen a consistent narrowing trend in the Fed funds rate. Ever more debt and ever cheaper money is required to maintain the illusion of growth.

And now the Fed is looking to cut rates with unemployment at 50-year lows and loose financial conditions offering abundant opportunities for credit. And rates are already low, with only 225 basis points to work with, the least amount of ammunition they ever had at their disposal at the end of a cycle.

These facts reveal an uncomfortable truth: Cheap money has not resulted in sustained new growth, but it has produced an unprecedented explosion in debt. And the Fed’s solution is now to offer more cheap money by cutting rates again.

But history suggests we should view this new round of rate cuts with caution. Each time the Fed has cut rates when unemployment was below 4%, a recession soon ensued.