Fed Cuts Interest Rate Cut For First Time Since 2008

August 1, 2019by Don Lee
Federal Reserve Chairman Jerome Powell testifies on monetary policy, before the House Financial Services Committee on Capitol Hill in Washington, D.C., U.S., Feb. 27, 2018. (Olivier Douliery/Abaca Press/TNS)

WASHINGTON — The Federal Reserve on Wednesday cut interest rates for the first time since the Great Recession in 2008, a risky move that clashes with its historical practice of taking such a step only when the economy is in real trouble.

The small, quarter-point reduction in its key rate is meant to be preventive medicine in the face of global economic uncertainties, such as the U.S. trade conflict with China and Britain’s messy exit from the European Union.

In announcing its decision after a two-day meeting, the Fed highlighted elements of a solidly growing economy but stated that it was acting “in light of the implications of global developments for the economic outlook as well as muted inflation pressures.”

The Fed statement signaled that the central bank was prepared to cut rates further, reiterating that it “will act as appropriate to sustain the expansion.”

That strategy is a departure from the past when the central bank typically acted only after seeing actual evidence of an impending downturn.

The economic effect of lowering the Fed’s benchmark rate to 2.25% from 2.5% will probably be muted.

Mortgage rates and stock prices already have factored in a rate cut; most corporations haven’t had trouble getting credit; and tweaking borrowing costs won’t boost car sales, which have peaked after years of strong pent-up demand.

But the danger is that interest rates are already low, and dropping them further not only nicks the Fed’s firepower when a real downturn comes but also could add fuel to stocks and other assets that are at very high levels.

“That is clearly the risk: It fans some bubbles,” said Ryan Sweet, an economist at Moody’s Analytics.

Even after Wednesday’s widely expected policy move, the Fed will almost certainly face pressure to lower rates further.

Over the past year President Trump has been hammering the central bank and his appointed chairman, Jerome H. Powell, out of fear that a slowdown could hurt his chances of winning reelection next year.

Trump tweeted this week ahead of the policymakers’ meeting that “a small rate cut is not enough.”

Powell and other Fed officials have pushed back on criticism that they would bow to the president’s demands, insisting that their policy decisions are independent from political influence and will be based on economic data.

But some analysts were unconvinced.

“The Fed’s decision today is like in the days when doctors bled their patients to heal them,” said Chris Rupkey, managing director at MUFG Bank in New York. “Fed officials made a very unwise decision today and buckled to the president’s demands by manufacturing reasons to cut interest rates despite a strong economy with no recession signs apparent anywhere out on the horizon.”

Two of the Fed’s 10 committee members voted against the rate cut, saying they preferred to keep it at the current level. At the Fed’s last policy meeting June 18-19, one member dissented. Discussions on further rate actions could create more division among Fed officials, making for more difficult decision-making.

In addition to lowering the Fed’s main overnight lending rate, officials said Wednesday that the central bank would halt its roll-off of asset holdings in August, two months earlier than scheduled. Some observers, including a very critical Trump, had viewed that reduction of the Fed balance sheet as having a tightening effect.

Wall Street will be pressing for more rate cuts, too. And it won’t be easy for Fed policymakers — who at times have given mixed or confusing communications — to manage those expectations.

The Fed, in announcing its decision on interest rates, also issued a statement summarizing its assessment of an American economy that has now grown consecutively for more than a decade, the longest period on record.

The Fed noted that household spending had picked up from earlier in the year and that the labor market continued to stay strong. It noted, however, that growth of business investment “has been soft” and that inflation measures remain low.

Shortly afterward, Powell was set to provide further guidance on monetary policy and the Fed’s latest thinking during a news conference.

Investors have been sensitive to every signal from the Fed, even if it involves just a small rate hike or cut. It reflects what analysts view as underlying insecurity in markets and an outsize reliance on the Fed to keep the party going.

The Fed in the past saw itself as a firefighter, but today it is more like a gardener that is expected to nurture an economy and keep it growing, said Dec Mullarkey, head of investment strategy at SLC Management, which manages $159 billion in assets.

And at the moment, the Fed is to trying to get ahead of a possible downturn as trade and other uncertainties have weighed on business sentiment and investments, he added.

“It’s an ounce of prevention is worth a pound of cure kind of move,” Mullarkey said.

He noted, however, that “it’s a dangerous game because markets now keep second-guessing you, and there’s quite a bit of feedback between markets and the Fed… You want the Fed to be leading that conversation, not reacting to it. And it’s complicated right now who’s doing what.”

Those pressures are, in part, of the Fed’s own making.

The central bank raised rates four times last year as the economy was rolling along, in a bid to wean the financial system from cheap money and return rates to more normal levels amid strong growth. But then Powell made an abrupt shift early this year, first pausing the rate-hike campaign and later in spring pivoting fully to a rate-cut bias.

Yet U.S. economic fundamentals have remained solid during that period. While growth has slowed from about 3% last year and through the first quarter, that was expected. Among other things, stimulus from the big tax cut that passed in late 2017 began to fade.

Even then, second-quarter growth was a healthy 2.1% and forecasters see the rest of the year performing about as well.

The latest data on consumer spending were strong, lifted by resilient job growth and solid income gains. And inflation, which has been undershooting the Fed’s 2% target and gave policymakers another reason to cut rates, is poised to inch higher.

Business investment was weak in the second quarter, and analysts attribute that partly to uncertainties stemming from the U.S.-China trade dispute and the multitude of tariffs imposed by each nation on the other. The two sides resumed negotiations this week but do not appear close to resolving their differences anytime soon.

Some economists, however, say the falloff in business spending for equipment and buildings is part of a cyclical slowdown and not an underlying threat to growth. And they don’t see the Fed having need to make further rate cuts after Wednesday.

In fact, the way things look now, the Fed could very well reverse course next year and push interest rates back up a notch, said Ken Matheny, an economist at Macroeconomic Advisers by IHS Markit, a leading forecasting firm in St. Louis.

Even though there is a case to be made for an “insurance cut” in rates, he said, financial conditions lately have become more favorable. And if the bipartisan budget that passed the House clears the Senate, as expected, that also could add a little more juice to growth in the second half.

“We think it’s a one-and-done,” Matheny said of Wednesday’s Fed action.

———

©2019 Los Angeles Times

Visit the Los Angeles Times at www.latimes.com

Distributed by Tribune Content Agency, LLC.

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