After great anticipation, the Federal Reserve finally reduced interest rates on July 31st. Their 25-basis point drop left the rate at 2% to 2.5%. The cut did little to appease the public clamoring for a larger rate cut. Jerome Powell, the current chair of the Federal Reserve, downplayed the necessity of further cuts. He explained that the 25bp cut was a “mid-cycle adjustment” – further adding that they did not see any weaknesses that would require further cuts.
However, most major players in the financial world are anticipating at least one further cut possibly by the end of 2019. Despite believing that further cuts are coming, Goldman Sachs also sees little reason for it. Cuts are generally used to bolster a flagging economy. Although the economy is stumbling due to the U.S.-China trade war and inconsistent executive policy, it isn’t at a level that would require more easing.
Why Would the Federal Reserve Cut Rates Further?
President Donald Trump is the largest force in the pro-rate cut camp. His rhetoric ramped up in recent months, urging the Federal Reserve to make significant cuts. He railed against the ‘quantitative tightening’ or QT policy currently in place. The fed began the policy in 2018 as the logical response to the ending of its highly-controversial “quantitative easing” program. Easing helped the economy recover from the 2008 recession, and tightening would help reduce the bloated Fed balance sheet from years of extensive market support activities.
Further, the Fed might decide to cut the rate further if the trade war continues to escalate, as we have seen in the recent weeks. While we are already seeing widespread impact from the trade war, most damage is restricted to import and export- based industries. The longer it lasts, however, the further economic damage will spread. Contrary to the U.S., China vowed to continue reducing the value of the renminbi.
Why Wouldn’t the Fed Cut Rates Further?
The Federal Reserve’s stated intent is to keep inflation at 2%. Doing so allows the Fed to maintain a cushion, should a recession necessitate more considerable cuts. The current environment does not qualify, so further cuts are unnecessary. Measuring inflation is difficult – which means that a target of 2% may in truth be barely be above zero.
Ultimately, there are very few-to-no real reason to cut rates currently. Trump’s incessant comments are aimed towards producing “good” economic figures. This, in turn, would avoid a negative public perception of his trade war. In reality, continuing the policy of quantitative tightening would help the average person more.
Article By: Adam Stone