Powell Pivots to a Rate Cut

Update 370 — Powell Pivots to a Rate Cut;
25 bps (Bonus Points) for Capital Markets
The old joke is that the Fed is there to pull the punchbowl away before the party ends in mayhem and tears.  This afternoon, the Fed re-filled the punchbowl and announced, if you can drink, please do. The first Fed interest rate cut since 2008 comes when inflation is tame and unemployment is low.  What could go wrong

The Fed, President and Congress are all rowing in the same direction now, with accommodation from the Fed and fiscal stimulus from Congress.   We could, if nothing goes wrong, see a turbo-charged economy heading into the 2020 elections. Progressives could mistake the rate cut for good news — what’s not to like about it?

We examine these questions from a policy and political perspective.

Best,

Dana

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Today, the Fed announced a reversal of course on monetary policy with major ramifications.  For the first time since 2008, the Fed has cut interest rates, contending that economic conditions and prospects have worsened significantly since last December, when the Fed raised rates by 25 basis points.

Rationale for a Rate Cut

Why a reversal since December? What has happened to change this outlook? The FOMC cites “global developments for the economic outlook as well as muted inflation pressures” to justify the move. In his Humphrey-Hawkins testimony earlier this month, Fed Chair Jerome Powell highlighted “crosscurrents” and “uncertainties,” but did not produce specific insight. Unemployment and inflation remain at constant and impressive lows, and the stock market is breaking records almost daily. 

The Fed’s decision is creating strange bedfellows, including President Trump, Rep. Alexandria Ocasio-Cortez, and the New York Times editorial board. Getting such a disparate group of stakeholders on board usually means it’s good policy, but that is not the case here. Lowering interest rates is unnecessary, and it will worsen economic inequality while improving Trump’s re-election chances. If he wins on the strength of an economic surge ginned up by the Fed, vulnerable Democrats may find maintaining their seats and their majority in the House more challenging.

Ambient or Real Economic Concerns?

Those who do cheer the Fed’s monetary activism can point to a few metrics. Second quarter GDP growth was 2.1 percent, with consumer spending driving growth and making up for real declines in both business investment (supposedly juiced by the 2017 Republican tax overhaul), and net exports (a victim of belligerent trade policy). This news disappointed many, including those in the Administration who continually promise three percent growth.

These trends are real and worrisome to an extent, but their solutions are better found in fiscal policy. The Fed has a specific dual-mandate: maintain low inflation and unemployment. Despite calls for the central bank to do more in terms of boosting economic growth and addressing income inequality, it is the wrong tool to do so. 

With the Fed’s move today, Trump can have it both ways — dampening economic growth through reckless trade and immigration policies to score political points, while the U.S. central bank provides stimulus in the form of monetary policy. With a tax cut maxing out the government’s fiscal firepower while failing to deliver on promises of wage growth, Trump is relying on the Fed to goose growth leading up to his re-election. 

More importantly, there is no need to cut rates. Consumer spending is strong, the stock market is breaking all-time records, and unemployment is low. The Fed should maintain a steady course and reserve firepower in the event of an economic downturn, rather than let the capital markets dictate monetary policy and potentially fuel the next asset bubble with cheap money.

Principled Objections from the Hill

Some members of Congress were skeptical of the Fed’s change of direction and tone during Chairman Powell’s Humphrey Hawkins testimony on July 10 and 11. In the House, Rep. Carolyn Maloney questioned the sudden change in rhetoric from the Fed given the “wait-and-see approach” that prevailed during the June FOMC press conference. She cited the strong job numbers in the June report as evidence that the real economy seems to be going strong. Reading between the lines, it seemed like she was asking whether it was the tail wagging the dog, as markets and the White House have made it clear that they want this rate cut. 

In the Senate, Republican Pat Toomey shared the same skepticism as Democrat Rep. Maloney over an imminent rate cut. Toomey has more professional experience in financial services than anyone on the Senate Banking Committee. He is bucking his party’s leader on an important issue, and his perspective might be worth considering. 

Modern Monetary Policy by other Means

A rate cut at this level, with record low unemployment, modest 2.1 percent Q2 GDP growth, and sub 4 percent mortgage rates will have little effect on the real economy. Rate changes have been shown to have only a tenuous relationship with real wage movements. 

When the Fed cuts rates, stimulus is injected into capital markets, where it spurs investment for those stakeholders.  Republicans and Trump constantly bemoaned low interest rates and Fed rate cuts during Obama’s presidency  — now they’re suddenly dovish on interest rates in an effort to prop the markets up to help Trump win in 2020. 

Economic Blessing Poorly Disguised

At this afternoon’s press conference, Powell said that the 25bp cut was a “mid-cycle adjustment to policy [to] insure against downside risks from weak global growth and trade policy uncertainty, and to promote a faster return of inflation to our symmetric 2 percent objective,” suggesting this doesn’t commit the Fed to further rates down the road.  The implication here is good.  

Of course, capital markets had a one percent tantrum on the news with a price fall during the news conference. However, perhaps markets would do well to heed President Trump who said in a November 2015 interview: “we’re in a bubble, and when those rates are raised, a lot of bad things are going to happen.”

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