Powell prepares to launch pivotal interest rate cut
Monetary policy pivot towards easing driven by four shifts in US Fed’s thinking
Jay Powell is this week widely expected to announce the first cut in US interest rates for more than a decade, as the Federal Reserve chairman seeks an insurance policy against a weakening global outlook and rising trade tensions.
If he follows through with the move, it would be the first reduction in the federal funds rate since 2008, the aftermath of the global financial crisis. It would represent a remarkable reversal from the tightening cycle Mr Powell pursued last year.
Swap contracts imply that investors have priced in a more than 80 per cent chance of a 25 basis point cut at the Fed’s monetary policy meeting on Wednesday, with nearly 20 per cent likelihood of a larger cut.
This comes despite the fact that the US economy is experiencing its longest- running growth streak since at least 1854, enjoys near-record low unemployment and record-high equity markets.
Behind the move lie four pivots in emphasis and thinking among Fed officials, each of which have contributed to the central bank’s change of direction.
Risk assessment
When Mr Powell signalled that the Fed was pausing its tightening cycle earlier this year, the bank stressed that its posture was one of patience. Any future change in policy would be dictated by incoming data — if it turned out to be stronger than expected, the Fed might return to increasing rates, while if economic indicators weakened it might resort to cuts.
Since then there have been some signs of a slowdown, with second-quarter growth coming in at 2.1 per cent, a big drop compared to 3.1 per cent in the first quarter.
The GDP showed substantial softness in business investment. But other parts of the economy are holding up. Consumption remains strong, as is the labour market which experienced solid employment growth in June.
What has changed is that the Fed’s evaluation of the risks to the economy is weighing more heavily than it did before. As a result it is set to act pre-emptively because of fears of the impact that trade tensions could have, rather than as a reaction to the actual fallout.
Global factors
US officials have always framed their thinking on trouble in the global economy — and markets — in terms of its spillover effects.
They could analyse and model the risks of contagion from problems in the rest of world, and make a determination as to the likely impact on the US economy. But there was always a sense that the US could operate as a distinct ecosystem.
By contrast, at a speech in Paris earlier this month, in his last public remarks before the upcoming FOMC meeting, Mr Powell showed that he is perhaps more attuned than his predecessors to the importance of “global factors”.