A Trump-shaped shadow over the Fed

September 19, 2019

Yesterday, at the FOMC, the US Federal Reserve (Fed) cut interest rates by 25 basis points to a range of 1.75-2%, as expected. On top of this, it cut the interest rate on excess reserves and the offering rate for reverse repos by 30bps to 1.8% and 1.7%, respectively, to help control short term money market rates. During the press conference, the Chairman, Jerome Powell, hinted that a resumption of balance sheet growth would be put on the table at the next Fed meeting, meaning that perhaps another rate cut could be substituted with some form of QE.

An updated dot-plot (a diagram revealing Fed officials’ projections for appropriate interest rate levels for the future) suggested little to no further cuts this year. The median estimate of the Fed policy rate is 1.75%-2% through 2020.

However, the projections also revealed that policymakers are deeply divided with regard to their perspectives about appropriate actions moving forward. Powell commented on this saying that we are in a time of “difficult judgements” and that “When the direction is relatively clear, it’s relatively easy to reach unanimity.” At the meeting yesterday three members dissented. Two Fed presidents — Kansas City’s Esther George and Boston’s Eric Rosengren called for no cut at all. Whereas Jim Bullard of St Louis wanted a larger cut of 50bp.This lack of consensus makes it difficult for Powell to commit to a clear path.

On one hand, global growth has slowed quite dramatically in the short timeframe from 2017 and the US is still embroiled in a trade war. On the other hand, the US economy seems to be doing ok for now. The FOMC assessment was little changed from the July one, apart from a more positive assessment of household spending (“rising on a strong pace”). With unemployment still at 40-year lows and consumer spending strong, the Fed, when embarking on its most recent rate cuts, labelled them as “pre-emptive”. The Fed did however note the weakening we have been seeing in business fixed investment and exports.

A Trump-shaped shadow hangs over the Fed, and after the meeting, he was quick to criticize the Fed. He accused the central bank and Fed Chair Jerome Powell of having “no guts” or “vision”  by not meting out a more aggressive interest rate cut as the global economy slows. But a key sticking point for the Fed is indeed Trump’s trade war with China. It is hard to judge whether the US economy needs more easing to cope with trade tensions. Given that the dispute could go one way or the other, the implications for future growth are unclear.

Should this intensify, the Fed will likely be waiting in the wings. Powell said:

“Sometimes the path ahead is clear, and sometimes less so.” “There will come a time, I suspect, when we’ve done enough. But there may also come a time when the economy worsens and we would then have to cut more aggressively. We don’t know.”

Markets expected a more dovish Fed, and initially equities sold off (they later recovered) and there was some flattening in the US yield curve.

Author: Group Investment Office