Fed Cuts Rates by a Quarter Point in Precautionary Move

Date: Thursday, August 1, 2019
Source: The Wall Street Journal

Central bankers say move protects against risks posed by muted inflation, global growth concerns

WASHINGTON—The Federal Reserve moved to cut interest rates by a quarter-percentage point—the first reduction since 2008—in a pre-emptive strike to cushion the economy from a global slowdown and continuing trade tensions.

Stock markets sold off and the dollar strengthened Wednesday afternoon after Fed Chairman Jerome Powell disappointed investors in his post-decision news conference when he didn’t more explicitly ratify expectations of additional stimulus in the months ahead.

The S&P 500 ended the day down 32.80 points, or 1.1%, to 2980.38, snapping a 36-session streak in which the closing index didn’t move more than 1% in either direction. Doubts about future rate cuts also sent the yield on the 10-year Treasury note to 2.034%, down from 2.063% on Tuesday, while the WSJ Dollar Index rose 0.37% to 91.25, near a 12-month high.

Mr. Powell said officials weren’t ruling out additional rate reductions, but neither did officials view Wednesday’s action as “the beginning of a long series of rate cuts,” he said. “You would do that if you saw real economic weakness…. That’s not what we’re seeing.”

Instead, he framed the decision to lower the Fed’s benchmark short-term rate to a range between 2% and 2.25% as a “mid-cycle adjustment.”

Eight of 10 Fed officials voted in favor of the move, while two officials dissented from the decision in favor of holding rates steady.

The policy statement released after Wednesday’s meeting indicated the Fed could cut rates again in the months ahead by saying that as it “contemplates the future path” of its policy rate, “it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”

Officials also announced they would end the runoff of their $3.8 trillion asset portfolio on Thursday, two months earlier than previously planned, halting a process that had been gradually withdrawing monetary stimulus that was added during the 2008 recession.

In June, seven of 17 officials indicated they believed rates would be a half-point lower by year-end, suggesting a significant reservoir of support for at least one more cut.

“Powell increased uncertainty around the direction of policy,” said Scott Minerd, chief investment officer at money manager Guggenheim Partners LLC. “The discussion around the future path of interest rates was ham-handed and probably undid a lot of the benefit of the rate cut today.”

Boston Fed President Eric Rosengren and Kansas City Fed President Esther George dissented from the decision. Both were among a group of Fed officials who had said recently they didn’t see a strong case for cutting interest rates because U.S. economic data has been good.

Mr. Minerd said Mr. Powell’s lack of crisp answers may have been a sign “the committee is not fully behind ongoing rate cuts.”

Because markets may have had unrealistic expectations about the Fed’s ability to signal more stimulus, “the risks were already skewed towards some degree of disappointment,” said Julia Coronado, founder of economic advisory firm MacroPolicy Perspectives. “There is already a strong lean for another cut. He basically told us that by referencing prior mid-cycle cuts.”

President Trump had called on Mr. Powell, who goes by Jay, to cut rates more aggressively and expressed his dissatisfaction on Twitter.

“What the market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle,” Mr. Trump wrote. “As usual, Powell let us down.”

The decision to lower rates reflects fears of an immediate pullback in growth as well as concerns about the Fed’s inability to generate more inflation, which is seen as a sign of healthy economic demand.

Mr. Powell said it was hard to be more specific about the Fed’s plans because of the fluid nature of trade discussions that have weighed on business investment and because officials wanted to see how the global economy digested the Fed’s efforts this year to ease policy, first by shelving plans to raise rates and now to cut them.

“We’ll be looking at weak global growth,” he said. “I would love to be more precise, but with trade it is a factor that we have to assess in kind of a new way.”

The decision effectively reversed the central bank’s December rate increase, which came during a period in which it believed interest rates were still low enough to spur growth and inflation. Since then, inflation has declined.

The unemployment rate, at 3.7% in June, is near a half-century low. The U.S. economy expanded at a 2.1% seasonally adjusted annual rate in the second quarter, buoyed by strong consumer spending. Also, stocks have been near records, largely in anticipation of Fed rate cuts.

But several sectors of the U.S. economy are slowing, including manufacturing. Others, such as housing, have rebounded due to the Fed’s decision to abandon rate increases at the beginning of the year.

So-called core prices, which exclude volatile food and energy categories, rose 1.6% for the year ended June, down from the central bank’s 2% target in December. While this may sound like a small miss, it is notable considering how officials last fall believed inflation would rise above the targeted 2% level without additional rate rises this year.

One risk from Wednesday’s market reaction is that the dollar continues to rise, particularly now that other central banks are moving to ease their interest rates. That would make it even harder for the Fed to raise inflation.

Fed officials see tighter linkages than in the past between U.S. and global economies, prompting new questions over how high they can keep domestic rates above those in other advanced economies, which have lower or even negative rates.

The Fed rate cut marks just the fifth time in the past 25 years that the central bank switched from raising to lowering rates. In the four prior cases, the Fed never cut rates just once.

Usually when the Fed starts cutting rates, it doesn’t know whether it will make a handful of small moves, as it did in 1995 and 1998 when the economy avoided a downturn—or whether it is the start of longer series of reductions, as in 2001 and 2007 when the central bank cut rates a few months before the economy entered recession.

The most recent Fed rate cut occurred in late 2008, when the central bank lowered its benchmark rate to near zero after the financial crisis. Officials left it there for seven years.

Wednesday’s decision ends a four-year effort to return monetary policy to what it looked like before the 2008 financial crisis.

During and after the crisis, the Fed bought more than $3.5 trillion in Treasury and mortgage bonds to stimulate growth.

Officials had expected that once the economy recovered, interest rates would eventually return to between 3% and 4% and that the bond portfolio would decline to around $1.5 trillion to $2.5 trillion.

Instead, this so-called normalization process has stopped with rates still at historically low levels and the Fed’s balance sheet much bigger.

The last time the Fed began cutting rates, in September 2007, the benchmark rate was 5.25%. And the asset portfolio is roughly $3.8 trillion, equal to around 18% of gross domestic product, up from less than $800 billion, or around 5% of GDP, at the end of 2007.

 

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