Federal Reserve faces decision whether to signal pause to rate cuts
Jay Powell expected to announce another ‘insurance’ cut this week
The Federal Reserve faces the thorny decision of whether to signal an interruption to its monetary easing after it delivers what is widely expected to be a third consecutive cut to its main interest rate this week.
Jay Powell, the Fed chairman, has described the rate-cutting drive he has overseen since July as a limited “mid-cycle adjustment” to insulate a resilient American economy from the impact of President Donald Trump’s trade wars and the global slowdown.
If the Federal Open Market Committee presses ahead with a new rate reduction on Wednesday afternoon, it will have already notched up 75 basis points of monetary stimulus this year — and to some economists and Fed officials that should be sufficient to accomplish the goal.
“I think they will end up cutting another 25 basis points [this week] and then pause for the rest of this year,” said Scott Anderson, chief economist at Bank of the West.
But a drumbeat of relatively soft economic data, and fears of a negative market reaction, could make Mr Powell and other Fed policymakers wary of indicating that this round of “insurance” cuts is already over. A new truce in the US-China trade war is only tentative. Even if it is signed by Mr Trump and Xi Jinping, China’s president, in Chile next month, many of the tariffs and the tensions in transpacific trade are set to linger.
“The Fed runs the risk of an unnecessary tightening of financial conditions. We are hopeful that Chair Powell avoids such a mistake,” said Joe Lavorgna, chief economist for the Americas at Natixis in New York.
All eyes on Wednesday will be on whether the FOMC statement changes it pledge to “act as appropriate to sustain the expansion” — an indicator of future rate cuts — to wording that appears less committed to further easing.
“Keeping the forward guidance as is is the path of least resistance. If they take it out they are being unintentionally hawkish,” said Michelle Meyer, an economist at Bank of America Merrill Lynch. “The data now is softening so I think they have to give some nod in that direction.”
Mr Powell’s comments at the subsequent press conference will also be key. The Fed chairman has faced a growing divide on the FOMC about the wisdom of interest rate cuts, as well as their timing, and that split risks widening in the coming months as the central bank decides whether to plough ahead with rate cuts or stand pat.
There could be some loss of credibility for the Fed, if having indicated that it was committed to a limited phase of monetary easing, it looked set to move well beyond that into a full-blown easing cycle. “We expect a slightly hawkish tone, with Powell alluding to a baseline of unchanged policy but emphasising data-dependence and the ability to respond quickly if the outlook deteriorates,” Spencer Hill, an economist at Goldman Sachs, wrote in a note called “3 and out?”.
“[The Fed] is not ready with a new framework to keep cutting rates to spur inflation, but there is not enough basis in the existing framework to act aggressively,” said Anne Mathias, global rates and FX strategist at Vanguard.
So far, the US economy appears far from sliding towards recession. The Atlanta Fed is forecasting that US gross domestic product rose at an annual rate of 1.8 per cent in the third quarter, a tick lower than the 2 per cent pace in the previous three months of the year. The IMF is predicting growth of 2.4 per cent this year, and 2.1 per cent in 2020. Job growth has slowed, manufacturing data have been soft and inflation expectations have moved down, but consumers have remained fairly strong and confident.
Fed officials may claim that they have successfully staved off a deeper slowdown this year, yet the global picture, which is mostly beyond their control, still looks very murky.
“We don’t really know what is going to happen with the trade war, we don’t know what is going to happen with Brexit, and there are tensions with Russia, North Korea and in the Middle East,” said Chris Iggo, chief investment officer of fixed income at AXA Investment Managers. “I’m willing to believe it’s a mid-cycle adjustment, but part of that is conditional on some of these geopolitical risks being resolved.”
Meanwhile, Mr Trump has continued to ramp up the pressure on them to continue cutting rates, and a presidential backlash is likely if the US central bank offers any hint of a break. This week, he accused the Fed of being “derelict in its duties” if it did not lower rates and stimulate the economy, setting Mr Powell as a scapegoat if growth does falter as he heads into the 2020 presidential election campaign.