Jay Powell reached for an old proverb on Wednesday to explain why the Federal Reserve might cut US interest rates to fend off the risks to the economy posed by slowing global growth and Donald Trump’s trade wars.
“An ounce of prevention is worth more than a pound of cure,” the Fed chairman told reporters.
But whether the central bank will pull the trigger on a pre-emptive monetary easing to keep the US expansion in good health — possibly as early as next month, as many investors are betting — is hardly a foregone conclusion.
Mr Powell emphasised that new information between now and July 31, the date of the next meeting of the Federal Open Market Committee, would be crucial to monetary policy. As well as routine economic data, this will include the outcome of a meeting at the G20 summit in Japan later this month between Mr Trump and Xi Jinping, the Chinese president, aimed a resolving trade tensions that have spooked businesses across the US.
“We felt it would be better to get a clearer picture of things and that we will learn a lot more about these developments in the near term,” Mr Powell said. “Ultimately, the question we will be asking ourselves is: ‘Are these risks continuing to weigh on the outlook?’”
Mr Powell spoke after he and his colleagues sent their strongest signal yet that an interest rate cut was looming. After a two-day meeting, where it decided to keep rates steady, the US central bank issued a policy statement citing rising “uncertainties” about the outlook posed by trade and some weakening in economic indicators.
As many as eight of the 17 Fed officials are predicting lower rates this year, according to charts released alongside the policy statement. Mr Powell said that the case for easing had strengthened even among the other officials.
“We will act as needed, including promptly if that’s appropriate, and use our tools to sustain the expansion,” he said.
In the end, the Fed bought itself more time to make a final decision, with almost all of the FOMC members believing that the case for a rate cut was not yet airtight.
One of the biggest challenges for the Fed in contemplating rate cuts is that US economic data has not deteriorated to the point where officials — and other economists — fear a sharp slowdown or recession, which would easily justify monetary easing.
In their statement, Fed officials said US economic activity was rising at a “moderate” rate, rather than a “solid rate”. But they are still expecting growth of 2.1 per cent this year and 2 per cent in 2020.
The other difficulty for Mr Powell is that US trade policy may remain uncertain for some time. The Trump-Xi talks at the G20 could result in anything from a new truce — including an agreement to engage in new negotiations and freeze further tariffs — to a full-blown escalation that would offer Mr Powell a much more straightforward case for easing policy. Although Mr Trump has temporarily dropped his threat to impose tariffs on Mexico, a failure by the southern neighbour of the US to curb migration could revive that possibility, which would be hugely disruptive to the US economy.
“The bar for cutting remains relatively high even if they’re telling people they might cut rates,” said Drew Matus, chief market strategist for MetLife Investment Management.
The Fed’s rate decision earned Mr Powell a dissent from James Bullard, the president of the St Louis Fed, who argued for a 25 basis point cut on Wednesday, raising the prospect of a growing rift within the US central bank about the course to follow.
Investors, however, are not banking on much more hesitation from the Fed. The markets-implied probability of a 25bp cut in the Fed’s interest rate corridor in July has jumped to 76 per cent, and the odds on a whopping 50bp reduction has jumped to 24 per cent, according to Bloomberg data. The probability of the central bank holding steady is now a minuscule 2 per cent. Moreover, the Fed funds futures market is pricing a greater-than-even chance that the central bank is forced to undo every one of its four 2018 rate increases by this time next year.
One indicator that has increasingly worried the Fed — and driven talk of rate cuts — is inflation, which has been running below the central bank’s 2 per cent target. In March Fed officials were predicting that core PCE inflation — their preferred measure — would hit that level this year, but they have lowered their estimate to 1.8 per cent.
“It has taken them a long time to get there but [the Fed] have basically come to the realisation that they cannot enhance inflation in a traditional way,” said Kevin Giddis, head of fixed income capital markets at Raymond James. “The fact that they cannot reinflate this economy beyond their expectations is why they need to cut rates again.”
Investor confidence that Mr Powell’s next move will be to cut rates is based on the sense that he has accepted the argument for action sooner rather than later. His comment about prevention being better than a cure was made in response to a question about research showing that more aggressive steps were needed to fend off downturns when rates were close to zero.
While the Fed chair said any near-term decisions would be driven by “incoming data and the evolving risk picture”, he was on board with that logic. “That is a valid way to think of policy in this era,” Mr Powell said.
Additional reporting by Joe Rennison in New York
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