Update 365: Powell Signals Pre-emptive Cut
Summer’s Sunny Sky Deceives or Fall Inevitable?
This seems like a point of departure for the Federal Reserve Board. It is rare for the Fed to reverse course on interest rate policy — raise and then cut rates in consecutive rate changes. It is passing rare for the Fed to cite 1.5 percent inflation as a reason for a cut. And it is well beyond rarer than sushi for a cut to occur when national unemployment is 3.7 percent.
But this is the countercyclical and counterintuitive course on which monetary policy is set under Fed Chair Jerome Powell, in a departure from precedent. Powell offered Humphrey-Hawkins testimony at House Financial Services this morning and we cover the key issues below.
This week, Federal Reserve Chair Powell delivers his semi-annual Monetary Policy Report to Congress. He answered questions before the House Financial Services Committee this morning. He will appear before Senate Banking tomorrow.
In today’s hearing, Powell hinted strongly at a 25 basis point interest cut that markets have already fully priced in. That is, only a change in course by the Fed away from the cut would provoke a market response, as evidenced by the marginal closing gains in the markets. The NYSE closed up 0.28 percent today. NASDAQ did finish at an all-time record high, gaining a percent today.
Democratic lawmakers praised Powell today for his independence in the face of Trump’s push to lower rates. Or maybe they are relieved that they have Powell — who was nominated to the Fed board by President Obama — sitting in front of them, as opposed to a Herman Cain or Stephen Moore.
No one on the Committee, Ds or Rs, raised concerns that a rate cut now might reduce the Fed’s monetary policy room for maneuver in the event of a crisis or recession — an objection that with rates at historical lows, discretionary rate cuts are unilateral semi-disarmament constraining the Fed when it actually matters later.
Bulls in Charge
Markets seem to be pricing in additional cuts this year; they may be disappointed. On June 25, St. Louis Fed president, and FOMC committee member, James Bullard suggested that an “insurance cut” of 25 basis-points would be enough to ward off any slowdown in economic activity. Today, Powell seemed to confirm that a rate cut this month would likely not be more than a quarter percentage point — reversing last December’s hike.
Seven Fed officials have penciled in a total of 50 bps by year’s end, with one official on record as expecting only 25 bps in cuts by then. At today’s hearing, Powell met market demand by hinting that he was prepared to cut interest rates.
Countercyclical, Yes. Counterproductive?
The economy is now in the 11th consecutive year of expansion. The Fed’s statistical northstars, inflation and unemployment, are almost unimprovably good. Capital market indices are near record territory. The stock market is up 17 percent so far this year.
Some might question the appropriateness of a cut right now, but expectations from the market support if not compel Powell’s decision, and this came up in the hearing. Sen. Pat Toomey of Pennsylvania, a Republican and former Wall Street executive agreed today that a cut under these circumstances may be “inappropriate.”
In the current and decade-long low interest rate environment, the stock market presents a better return on investment than traditional savings accounts. Stock prices enjoy a strong inverse relationship with the federal funds rate — interest rates go down, asset prices go up. Powell can not ignore market sentiment, but his testimony today suggests that any change in direction by the Fed will not be made in haste and without proper consideration of the macroeconomic picture.
When questioned by Rep. Maloney on the wisdom of lowering rates in a period of economic expansion and job growth, Chair Powell responded by defending possible rate cuts, saying: “manufacturing, trade, and investment are weak across the world… uncertainties continue to weigh on our economic outlook.”
The Fed faces an institutional problem: absent fiscal stimulus driving the economy, just how much power (what “tools,” in Powell’s words) does it have to maintain the country’s economic well-being and stave off the next recession?
Noms: The Gold Standard?
While Candidate Trump and fellow Republicans spent much of the 2016 campaign criticizing the Fed for keeping rates too low, President Trump has demanded the central bank lower interest rates to continue the economic expansion.
Last week, the president announced his intention to nominate Judy Shelton and Christopher Waller to open seats on the Fed Board. Shelton and Waller would likely support the president’s call for low interest rates; both have expressed skepticism that low unemployment always leads to high inflation. The nominees will likely advance, as Shelton was unanimously Senate-confirmed to her current position and Waller is a relatively nonpartisan pick.
- Judy Shelton is a longtime Republican political operative who currently serves as the US executive director at the European Bank for Reconstruction and Development. A PhD in business administration, she has bucked conventional economic thinking by advocating for a return to the Gold Standard.
- Christopher Waller is a less controversial Fed Board nominee. Waller joined the Federal Reserve Bank of St. Louis in 2009 after teaching economics at the University of Notre Dame and the University of Kentucky. He serves as vice president and director of research at the St. Louis Fed and is best known for a commitment to low interest rates.
Taking the Stress Out of Stress Tests
Since the signing of S. 2155 in 2016, the Fed has proposed and implemented ‘tailoring’ measures that undermine the Comprehensive Capital Analysis and Review (CCAR) stress testing regime that ensures banks have liquidity to survive a severe downturn in the economy. This year’s results were published on June 27. Yesterday, Powell called the annual stress tests one of the “most successful supervisory innovations” since the financial crisis.
Despite this, the Fed has implemented various ‘tailoring’ proposals that serve to subvert and weaken the stress testing regime. At today’s hearing, Republicans demanded even more leniency for big banks. Powell was pressed on whether the Fed would consider revising its stress capital buffer proposal so that banks could average stress test losses over several years. Under this scenario, a bank could fall below post-stress minimums in a given year without failing the test. Powell said that they are “in the late stages” of evaluating this change, but didn’t rule it out.
The biggest takeaway from today’s hearing is that an imminent rate cut is almost certain. Chair Powell is taking pressure from all sides: the impatient stock market, an inquisitive Congress, and a president looking to oust him. During tomorrow’s hearing, Republicans and Democrats alike will tout the humming economy and Powell will be made to defend seemingly unnecessary rate cuts.
Will Fed-speak dominate once again? Concerns about general ‘economic uncertainty’ did some heavy lifting today, but more specifics are needed to gauge the size and strength of ‘headwinds’ and ‘crosscurrents.’ And for workers, why have wages not increased with sustained low unemployment? Is the so-called ‘skills gap’ entirely to blame, or are our models in need of reconsideration? Much to consider and best to Senate Banking in sorting it all out tomorrow.