Fed is coming to another tipping point
Yet economists split on if the third will be last
With a rate cut expected this week, economists are divided on where the central bank will go from there.
Will the Federal Reserve be done lowering interest rates, at least for 2019, after an expected third cut this week?
The U.S. central bank is likely to provide some clues to help answer that question after a two-day meeting that ends Wednesday, though it almost certainly will keep its options open and dependent on economic data.
Economists are divided on whether Fed officials will leave the door wide open to another cut at their next meeting in December or hint that they’re inclined to pause.
Whatever they signal is likely to move markets during a volatile period for stocks. And what they ultimately decide will determine whether consumer borrowing costs and bank savings rates will continue to edge down.
For the record, Fed officials have been circumspect even about their immediate plans, repeating that they “will act as appropriate to sustain the expansion” but stopping short of providing a clear sign that they will lower rates this week. Yet a gauge of upcoming fed moves – fed fund futures markets – says there’s a 93% chance of a rate cut, and Fed officials have said nothing to contradict that assumption.
“We think it’s very unlikely (the Fed’s policy committee) will disappoint the market,” says economist Michael Feroli of JPMorgan Chase. If it did, the resulting drop in stocks and rise in longer-term interest rate could hurt the economy, making the Fed’s task even more difficult.
Fed officials have repeated that they “will act as appropriate to sustain the expansion.”
The bigger issue is that the Fed is at a crossroads in its campaign to reduce rates to head off a potential recession. After this week’s anticipated move, the Fed will have trimmed its federal funds rate by a quarter percentage three times since late July. That would equal the 0.75 percentage points in cuts the Fed enacted in 1995-96 and 1998.
That milestone is significant because those 1990s-era reductions, like the current ones,have been made while the economy is still growing. The goal is to ward off a recession rather than to lift the economy from a downturn.
Taking a break from rate cuts?
Many Fed policymakers likely believe they should now take a breather “to let the full effect of lower interest rates run its course,” Morgan Stanley said in a research note. Put simply, it takes time for rate cuts to reduce borrowing costs for consumers and businesses, spurring growth. So why not see if the three rate reductions so far have done the trick?
That’s especially the case since the economy isn’t in dire straits and there’s always some concern that slicing rates too much could eventually ignite inflation or risky bubbles in stocks and other assets.
Since the Fed last cut rates in midSeptember, a split-screen U.S. economy has persisted. A sluggish global economy and the U.S.-China trade war have hurt manufacturing and business investment, while job growth and consumer spending have slowed but remain solid.
Feroli notes, however, that two clouds over the economy have dissipated somewhat. The U.S. has reached a trade deal with China that partly resolves the two countries’ differences. And the risk of a “hard Brexit” that doesn’t include agreements between Britain and Europe has been reduced. Long-term Treasury yields have risen above short-term rates again after that traditional relationship reversed over the summer, signaling a dim outlook.
Goldman Sachs argues the Fed will go further, replacing its assertion that it will “act as appropriate to sustain the expansion” withlanguage that couldsignal even more clearly that the Fed isn’t on course to trim rates again in December, unless the economy worsens.
That message would serve a couple of purposes. Fed policymakers are sharply divided over whether rate cuts are needed and several have said they should provide the public more clarity on when they’ll end, according to minutes of a September Fed meeting.
Morgan Stanley agrees the Fed is likely to pause after Wednesday’s rate cut but probably won’t signal that intention in its statement or in Powell’s press conference to avoid roiling stock and bond markets.
“We think the (Fed) will be careful in its statement, and in Chair Powell’s Q&A, to deliver a message that aims to keep financial conditions steady,” Morgan Stanley wrote to clients.
Should Fed keep cutting rates?
Other economists have a warier view of the economy. Kathy Bostjancic of Oxford Economics expects growth of about 1.3% the second half of the year, down from 2.5% in the first half, noting the risk that the troubles in U.S. manufacturing could spill into the service sector, the main driver of the U.S. economy.
And the proposed trade deal – which suspends planned U.S. tariffs on Chinese imports in exchange for more shipments of U.S. goods to China – does little to resolve the dispute, Bostjancic says. That conflict centers on deeper issues such as China's requirement that U.S. companies transfer proprietary technology to access its market.
As a result, existing tariffs by U.S. and China are still set to shave economic growth by nearly half a percentage point next year, she says.
Meanwhile, the Fed's preferred measure of inflation remains below its annual 2% target, giving it more leeway to cut, Deutsche Bank says.
“I think (Fed officials) wouldn’t mind pausing but economic data will push them into (another rate cut),” Bostjancic says.
But what about the 1990s precedent – three cuts and out?
Deutsche Bank drew a distinction between the economic backdrop that sparked the three rate cuts in 1995-96 and today’s conditions.
“Economic policy uncertainty, particularly related to trade policy, is substantially higher (now) than during that earlier episode,” Deutsche Bank said.
After this potential move, the Fed will have trimmed its federal funds rate by a quarter percentage three times since late July.