08.01.2019 0

Fed rate cut unsurprising in context of China and Europe devaluations, weak inflation



By Robert Romano

The Federal Reserve is cutting its key interest rate to a range of 2 percent to 2.25 percent, the central bank announced on July 31, citing slowing inflation. The statement noted, “overall inflation and inflation for items other than food and energy are running below 2 percent.”

The last inflation number came in at 1.6 percent over the past twelve months, and so the move is unsurprising.

The decision was also coupled with the decision by the Fed to stop selling securities back to the market sooner than expected. According to the release, “The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated.”

The Federal Reserve has dumped $621 billion of U.S. treasuries and mortgage-backed securities since it began its policy normalization program in Sept. 2017.

The move also comes as China has continued to devalue the yuan another 3 percent in response to the imposition by President Donald Trump of 25 percent tariffs on up to $250 billion of goods shipped to the U.S., and Europe’s recent statement in June that it could be preparing to cut interest rates.

In that sense, the central bank’s decision could be viewed as a competitive devaluation, intended to stave off potential deflationary forces brought on by external actors.


 

President Donald Trump weighed in on the move, embracing a rate cut but blasting the Fed for not definitively clarifying future rate cuts.

“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 which would keep pace with China, The European Union and other countries around the world,” Trump wrote on Twitter.

Trump added, “As usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place — no inflation.”

To be fair, the Fed did say it would cut further as necessary, but offered no timetable: “As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”

The move also comes amid key rate inversions. On May 23, the 10-year Treasury dipped below the federal funds rate where it has stayed since. Similarly, the 10-year-3-month spread has been inverted during that same time. Now with the federal funds rate cut, it appears poised to relieve the inversions.

Which in turn may forestall the need for further rate reductions and help to bolster domestic growth, which slowed in the second quarter. We’ll see. The Fed doesn’t have much room to cut rates, so when the push toward zero percent begins again, we might be able to safely predict that the next recession is imminent. If, however, the Fed pauses from its current position, that could mean we’re still mid-cycle.

In other words, President Trump might be careful what he wishes for.

All of which has implications for 2020. A recession would upset the apple cart and make it more difficult for President Trump to be reelected.  Naturally, that’s why  Trump might be upset. The Fed waited too long to raise rates when it could have perhaps safely done so back in Obama’s second term. Now we’ll never know the counterfactual, but we will know how the economy is doing next year. If the Fed’s rate cut gambit pays off, the dollar keeps footing with the yuan and euro, and the economy keeps growing, unemployment stays low and inflation ticks up a little, President Trump may not have much to complain about next year. Stay tuned.

Robert Romano is the Vice President of Public Policy at Americans for Limited Government.

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