An Urban's Rural View

Within days of the Federal Reserve's broad hint on July 31 that an interest-rate cut is coming in September, the prospect of lower rates gained support from two big developments.

The one that got the most attention was the dramatic worldwide stock-market crash Aug. 5, in which the S&P 500 fell 3% and Japan's Nikkei plummeted 12%. Stocks recovered the next day, but volatility (which means fear) is high, so more bad news for stocks could lie ahead. Some panicky Wall Streeters called for the Fed to hold an emergency meeting and lower interest rates a whopping three-quarters of a point.

The more important development was the Aug. 2 report that unemployment in the U.S. rose another two percentage points in July from June, to 4.3%, and was up eight percentage points from a year ago. While 4.3% is not a terrible unemployment rate, the continuing increases raise the possibility that a recession looms.

That unemployment report could have caused stocks to rise. On numerous past occasions bad news for the economy has been good news for stocks, raising hopes of interest-rate cuts. Lower interest rates make bonds less attractive and stocks more attractive.

This time, though, stocks fell the day of the report, as investors feared the Fed had waited too long to lower rates and could no longer fend off a recession. Recessions aren't good for stocks.

In addition, markets began anticipating a bigger Fed reaction. Before the unemployment news, investors were anticipating a quarter-point cut in September. After it, they're pricing in a half-point cut.

It's best to think of the stock market crash three days later as only tangentially related to the unemployment report. It began in Japan and was first of all a reaction to events there. Japan's central bank had recently raised interest rates for the first time in years, giving a big boost to the value of the yen. That's bad news for Japanese exports.

It's bad news, too, for Americans and Europeans who've borrowed yen at low interest rates, converted the funds to dollars and invested the proceeds in high-yielding American financial assets. They rushed to unwind this so-called "carry trade," selling the American assets and pulling U.S. markets down.

And, of course, many American investors had felt stocks were overvalued for some time but had kept buying and realizing big paper gains. Once the big selling began, they decided to lock in some of those gains before they evaporated. Selling prompted selling.

Supporting financial markets is not one of the Fed's jobs. Some market crashes have been so serious -- think 2008 -- that the Fed has been forced to intervene lest they throw the economy into depression. This latest crash doesn't come close to qualifying.

Unless things get much, much worse and a genuine financial-market meltdown occurs, there won't be any emergency Fed meeting. We'll all have to wait for the Fed's regular September meeting.

What happens next will be interesting to watch. If the government statistic mills pour out more bad economic news, the Fed could very well lower interest rates a half-percentage point or more at its September meeting.

If the economic news remains mixed, especially if the unemployment rate remains at 4.3% or even goes down in the months ahead, the Fed will have to debate in September whether to cut more deeply than a quarter point.

The worst-case scenario would be a resurgence of inflation combined with further increases in unemployment. That would put the Fed in a bind: Higher rates to fight inflation? Lower rates to cure unemployment?

Over the past couple of years Fed officials have made two things clear. One, they won't lower rates until they're confident inflation is headed to their 2% target. Two, if bringing inflation to 2% requires putting the economy in recession, they're willing to pay that price, as much as they'd prefer a "soft landing."

While a hard landing might hasten interest-rate cuts, it would leave millions of Americans jobless. No one should want that.

We're on the cusp of getting both interest rate cuts and a soft landing. That's the best-case scenario farmers and ranchers and indeed all Americans should be hoping for.

Urban Lehner can be reached at urbanize@gmail.com

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