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Home / Business / A Fed interest rate cut is in the bag. What?

A Fed interest rate cut is in the bag. What?



SAN FRANCISCO (Reuters) – US central bankers are expected to lower borrowing costs this week for the first time since the financial crisis more than a decade ago. That's the easy part.

FILE PHOTO: Federal Reserve Board Member Jerome Powell testifies before a Senate Banking, Housing and Urban Affairs Committee on the "Semi-Annual Monetary Policy Report to Congress" on Capitol Hill in Washington DC, USA, July 11, 2019. REUTERS / Leah Millis

Whether it initiates a series of quarterly interest rate cuts that could extend well into next year, as financial markets are betting, or somewhat more limited, is far the harder decision facing Federal Reserve policy makers.

One reason: No clear consensus from Fed officials on why they need to cut interest rates in the first place, especially with the US unemployment near a 50-year low and the US economy putting together as the best in the class among developed nations .

Is there a bit of insurance against risks that is slowing global growth and trade tensions? A step to strengthen weak inflation? A bid to lift labor markets further? An attempt to break the bond market? Over the past few weeks, Fed makers have moved each of these ideas and others.

New York Fed President John Williams even briefly convinced markets that the Fed was planning to cut interest rates by half a percentage point this week, until the New York Fed issued a statement explaining that his remarks about "vaccinating" the economy against serious illness was of a professional nature and not intended to signal political decisions in the near term.

Complicating matters is the Fed's desire to make it clear that loosening monetary policy is not a reaction to months of pressure from US President Donald Trump to do just that.

Investors should be given some clarity when the Fed's interest rate committee releases its policy statement at 2 p.m. EDT (1800 GMT) Wednesday after the two day meeting ended. Fed Chairman Jerome Powell will hold a press conference shortly after.

CROSS CURRENCY

Economists and traders overwhelmingly expect the Fed to cut the key policy rate by a quarter of a percentage point on Wednesday, corresponding to the size of each of the nine rate hikes the Fed delivered from 2015 to 2018.

The big debate at the 30- July 31 will be about what's next and how to communicate it, said macroeconomist Roberto Perli.

"I bet the statement will … leave the door for more, to at least another 25 (basis points) down the road," Perli said.

But as to which financial threshold would trigger a further interest rate cut, he said, "I don't think they have a clear idea."

The federal fund rate is currently set in a range of 2.25% to 2.50%. Traders of futures tied to the exchange rate have priced in a full percentage point by the end of next year. But the economic picture now is quite different from the last times the Fed has cut interest rates.

Since the Fed's last interest rate setting meeting in mid-June, financial data on retail sales and job creation have been stronger than expected, and lasting orders, a proxy for business development plans, jumped in June. At the same time, US home sales fell, the industry has been weak for months, and exports are down.

A report on Friday showed that high consumer spending kept the US economy up 2.1% in the second quarter, a smaller decline than expected. But it also underscored the weak business investment and inflation that has worried Powell.

The competing threads are likely to lead to a strong debate during the meeting as to whether a cut in interest rates is needed, and may limit how much more relief can be signaled.

"I think it's a stretch to believe that this is or should be the beginning of a relief. It's simply not justified," said Ward McCarthy, chief economist at Jefferies.

Some Fed politicians, including Kansas City Fed President Esther George and Boston Fed President Eric Rosengren may even go so far as to register their reservations for further relief with a formal dissent.

"MORE LEEWAY"

Still, the Fed has a lot to

Signs of weakness in Europe and China and the prospect of new British Prime Minister Boris Johnson making a messy exit from the European Union have increased the odds of interest rate cuts abroad, with the European Central Bank all looking to facilitate policy comes September.

Some view foreign spending cuts as a case for reducing US prices.

There has actually been a main argument from Trump, who has accused foreigners of central bankers to use monetary policy to devalue their currencies, and urged the Fed to do the same.

In the Fed's next step survey, investors will not have any "dot plots" to consult, as they have had after each other political grip since the Fed began in 2012 to publish quarterly interest rate forecasts from individual policy makers.

Because these forecasts have at times been contrary to the Fed's agreed political message, their absence may actually make Powell's task easier.

FILE PHOTO: The Federal Reserve Board building on Constitution Avenue is pictured in Washington, USA, March 19, 2019. REUTERS / Leah Millis

“Not having the estimates this month gives them much more leeway in sending a message about "We will respond as justified," said Richard Moody, chief economist at Regions Financial Corp.

The Fed could also put an early end to planned reductions in the $ 3.8 trillion balance sheet, built up over years of bond purchases following the Great Depression 2007-2009. The runoff, seen as a tightening of the margin policy, is in any event planned to be completed in September.

Ending it a little early can get rid of criticism that balance policy works across purposes of interest rate policy. And if the Fed were to disappoint the markets by signaling further interest rate cuts are less than a sure thing, Moody said, a change in the balance sheet could be a "comfort premium."

Reporting by Ann Saphir; Editing by Dan Burns and Paul Simao

Our Standards: Thomson Reuters Trust Principles.

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