The Federal Reserve is almost sure to disappoint investors at its monetary policy meeting tomorrow. It is all but certain to cut its benchmark federal funds rate by a quarter point, to 2.00-2.25 from the current 2.25-2.50. If it doesn’t do that, markets will throw a fit, but even if it does, it’s not likely to be enough.
Given steady growth in the economy, record low unemployment and muted inflation, the Federal Open Market Committee will have to spin the rate cut as a so-called insurance cut – that is, one designed to make sure that growth continues.
The problem is that a quarter-point doesn’t buy much insurance. If the goal is only to un-invert the yield curve and push short-term yields back below long-term yields where they belong, a quarter-point cut is likely to do it. The yield differential between the 3-month Treasury bill and 10-year Treasury note has narrowed to about that.
But the technicality of turning off the recession warning doesn’t do much to boost the economy. That is why market participants are looking for further rate cuts in the next few meetings, starting in mid-September, when fed funds futures give a 70 percent chance for another cut, to 1.75-2.00 or lower. At the FOMC meeting in December, futures put the odds of a cut to 1.50-1.75 or lower at better than even.
Time To Cut To The Chase
The market reaction this week depends a lot on how the committee phrases its consensus message and most of all on how Fed Chair Jerome Powelll explains the thinking of policymakers.
If he continues to emphasize headwinds and risks to the economy, especially from trade tensions, investors can maintain their belief that further cuts are in store.
But in that case, if the Fed knows that this quarter-point cut won’t be enough, why doesn’t it just cut to the chase, so to speak, and bring a little shock and awe into this process? A bold half-point cut would ensure the Fed is getting enough insurance to sustain growth.
A Bold Move Would Be More Effective
Nothing the Fed will do this week can push inflation up to its 2% target, let alone above it to realize its ideal of symmetrical inflation that runs above 2% to compensate for all this time below the rate. But a half-point cut would do more to unleash the forces that would accelerate price increases.
That, however, is not going to happen. The best investors can hope for is that Powell will keep the door open to further cuts soon.
The problem is that Powell has proven to be somewhat fickle in his views, depending on which way the wind is blowing. He swerved from wanting steady rate hikes, to wanting a patient Fed to sit on rates, to virtually guaranteeing a rate cut is in the offing.
Who's Calling The Shots?
So what’s next? More rate cuts or a return to patience? And if Powell is reactive, who is calling the shots?
President Donald Trump has been hounding the Fed to cut rates, and is finally getting his way after he has called them every name in the book – incompetent being one of the nicer ones.
For all the lip service Fed officials give to remaining independent in the face of this presidential onslaught, an observer from outer space might get the impression they were following Trump’s command, though with considerable foot-dragging.
What’s more likely, however, is that they are following obsolete doctrines entrenched in the mindsets of the massive staff of economists who help Powell and other policymakers decide what they think. Not a prescription for bold moves or even consistency from one meeting to the next.