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Make no mistake, the Fed will pay a premium when it reduces prices this month



"If you're driving in fog, ice or snow, the most important rule is to keep your distance. There are rule number one, two, three … and up to ten."

This was told to me by it nice person who takes us to Zurich airport today. He referred to driving in winter weather here. For me, it perfectly took the dilemma of the Federal Reserve, as it determines how much to cut the interest rate at the end of this month (yes, it's not a question of cutting it but with how much).

<p class = "canvas-atom canvas text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "While the US economy is facing" cross-currents " It remains in a "good place" (using two of Chairman Powell's favorite descriptors) – that is, at least, domestic economic momentum can at least overcome heads from slowing global growth, trade uncertainties, and increasing currency fluctuations. , convicted from Fed Chairman Powell's comments to Congress last week is the world's most powerful central bank in the process of cutting prices, thereby also opening the door to central banks elsewhere to facilitate their monetary policy. "17"> While the US economy is facing "cross-currents", it stays in a "good place" (using two of Powell's favorite descriptors) – that is, the domestic economic momentum is in place, at least for now , to overcome headwinds from slowing growth in the rest of the world, trade policy uncertainties and increasing currency tensions. Yet, judging from Fed President Powell's congressional comments last week, the world's most powerful central bank is cutting prices, opening the door to central banks elsewhere to ease their monetary policy.

U.S. Federal Reserve Chairman Jerome Powell said Wednesday that cross-currents such as trade tensions and concerns about global growth have weighted US economic activity and prospects. (Photo by Liu Jie / Xinhua via Getty)

It is difficult to justify a price reduction using traditional calculations. Unemployment is five decades low, inflation is not so far below Fed goals, financial conditions are the smallest in almost two decades, stock indices are at record highs, and interest rates are already at low levels. Nevertheless, the Fed is under enormous market and political pressure to cut. And it will do so by referring to the term "insurance cutback" – that is, increasing money stimulation now to reduce the risk of future damage.

But as most assurances you and I get, the Fed's embrace is not free from four main reasons:

  • The more the central bank is doing now, the less space it must cut later if the domestic economic moment decreases. (Remember that the current US economic expansion is already unusually long, and has also set a new record less month.)

  • The greater the political easing, the stronger the signal to investors and traders to expand their risk appetite even more – and this at a time when several indicators of excessive risk taking are already flashing yellow if it is not red.

  • With slight unlikely to have much beneficial economic effects, corporate and economic fundamentals will slow down further elevated property prices, thus highlighting threats of future financial instability that may cause financial harm.

  • The more the Fed stimulates when the economy is in a good place, the more it will be seen as undermining unnecessary pressure from markets and White Houses. This can damage its credibility and undermine the effectiveness of its future political guidance.

The Fed will balance all this at its meeting on July 30 to July 31 in its Federal Open Market Committee (FOMC). And with the possibility of not reducing interest rates (as would probably trigger significant market volatility and quite a political response), the question of reducing interest rates by 25 or 50 basis points.

The most likely result – and there is a high probability one – is a 25 bps cut, wrapped in languages ​​that allow for multiple reductions later this year, thus reducing the risk of market and political setbacks.

But make no mistake, the Fed will pay a premium for this insurance cut and there is a premium that could prove significant if the economy were hit by a rough patch due to either domestic or external disruption.

<p class = "canvas text 0) – sm Mt (0.8em) – sm" type = "text" content = " Mohamed A. El-Erian is CFO of Allianz, the company parent of PIMCO where he served as CEO and co-CIO (2007-2014) .A Bloomberg columnist and Financial Times contributing editor, he was head of President Obama's Global Development Council and authored two New York Times Bestsellers: 2008 "[19659017] When Markets Collide "and 2016" The only game in town . "" data-response time = "40"> Mohamed A. El-Erian is financial advisor to Allianz , the company's parent for PIMCO, where he served as CEO and co-CIO (2007-2014). A Bloomberg columnist and Financial Times contributing editor, he was head of President Obama's global development council and authored two New York Times Bestsellers: 2008 " When Markets Collide " and 2016 " The Only Game in city ​​. "

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