Donald Trump’s demands add to Federal Reserve interest rate headaches
Political pressure for a cut makes the US central bank’s next decision vexed
Donald Trump’s renewed public demand for easier monetary policy has injected a further political dimension into decision-making at a Federal Reserve that is anxious to display its independence.
Having raised interest rates four times last year, the US central bank faces a debate over whether the next move will need to be down rather than up. The president’s willingness to trample over the Fed’s independence will only make the next decision more vexed given central bankers’ desire to prove they are not being steered by politicians.
“To expect that the next move might be a cut is not crazy,” said Joe Gagnon, a former Fed official who is now at the Peterson Institute for International Economics. However “it is awkward for them to do what he has asked them to do”.
Following fears of a recession in the bond market, optimism about the US economy revived late last week, with March jobs growth approaching 200,000 and unemployment hanging at just 3.8 per cent. The numbers were easily strong enough to reinforce the Fed’s central case for 2019, namely for respectable economic growth and unchanged interest rates.
But the case for a rate cut could yet materialise this year. If the US sees signs of a serious downturn there is little doubt that chairman Jay Powell and his colleagues would cut aggressively. Some officials could start seeing arguments for a downward move even if the economy is not falling off a cliff.
It would take a lot of disappointment from here to get a cut
Michael Feroli, JPMorgan Chase
The rate adjustments under former Fed chairman Alan Greenspan during the record-breaking expansion of the 1990s serve as one set of precedents. Charles Evans, the Chicago Fed president, in late March discussed Mr Greenspan’s rate cuts during the 1998 emerging markets crisis as an example of what he calls a “risk management” approach to policy.
The Fed lowered rates even though US unemployment was just 4.6 per cent and America’s gross domestic product growth remained steady. It was an example, Mr Evans said, of the Fed easing policy “as insurance against bad outcomes”.
Bill English, a Yale professor who used to be director of the Fed’s division of monetary affairs, said reductions pushed through by the Fed earlier in the 1990s are also relevant. In July 1995 the Fed started reversing an earlier series of rises by lowering rates by a total of three-quarters of a point — even though the economy was by no means cratering.
If the US economy slows later this year and inflation is low, the Fed could make a similar “midcourse correction”, Mr English said. Adding to present-day arguments for the Fed to act pre-emptively is the relatively low current level of neutral interest rates — rates that neither stimulate growth nor hold it back. This is leaving the central bank only modest firepower to prop up the economy.
“You react more sensitively to slower growth than in normal times,” Mr English said. “You might want to lean in the direction of easier policy to provide more of a buffer against downside shocks.”
Michael Feroli of JPMorgan Chase questioned arguments for rate cuts, saying the US is on course for above-trend economic growth. The 1995 reductions were a necessary response to excessive tightening the previous year, he said, and in 1998 the Fed was reacting to a genuine market crisis. The situation is different today. “It would take a lot of disappointment from here to get a cut,” he argued.
Alan Blinder, a former Fed governor who is now at Princeton University, said that as a general rule the Fed needed to be ready to move pre-emptively in both directions, but it was not currently clear to him that risks of worse than expected outcomes were overshadowing those of quicker inflation.
While Fed officials including Richard Clarida, the vice-chairman of its board, have been highlighting global hazards such as trade tensions, slowing growth and Brexit, the US has generally proved to be resistant to foreign shocks. The danger for the Fed is that any hint it had started to consider a rate reduction could panic financial markets, as traders ask whether the central bank sees a dire prognosis they have overlooked.
The Fed would also need to confront one of the principal critiques of Mr Greenspan’s 1990s policy — namely that it was so loose that it stoked up hazardous bubbles in financial markets. The cuts in late 1998 have been criticised in particular as being ill-advised and unnecessary. “You don’t want unintended consequences like a sharp appreciation in housing,” said Diane Swonk of Grant Thornton. “You could have bigger bubbles in financial markets.”
Accusations that Mr Powell caved to presidential pressure in shelving the Fed’s rate-raising campaign early this year are further bedevilling the policy outlook. An outright cut would reinforce claims that Mr Trump is influencing policy at a central bank that jealously guards its independence. “It makes the job more complicated — and it’s already a complicated job,” Mr English said. “It’s unfortunate.”