Federal Reserve officials lay out case for aggressive rate cuts

Federal Reserve officials lay out case for aggressive rate cuts

Federal Reserve officials signaled they are ready to cut interest rates by a quarter-percentage point at their coming meeting, while indicating the potential for additional reductions because they are worried about a slowdown in global growth, an increase in trade-policy uncertainty and a pullback in inflation.

Officials aren’t prepared for bolder action by making a half-point cut, as analysts and traders have speculated in recent days, according to the officials’ recent public statements and interviews.

The larger move appears unlikely for now because officials have said recent economic developments haven’t signaled an imminent downturn.

Fed Chairman Jerome Powell set the stage for the cut last week during congressional testimony, when he signaled concern about global growth and the risk of a more prolonged shortfall in inflation from the Fed’s 2% target. Those developments strengthened the case for a somewhat easier policy stance, he said.

The upshot is that — barring unexpected economic developments between now and the July 30-31 meeting — the bigger debate will center on how to signal their plans and outlook beyond July.

Market expectations of a half-point Fed cut swelled Thursday afternoon after New York Fed President John Williams delivered a speech expounding upon 20 years of theory and practice that indicates more aggressive and pre-emptive action is warranted when the economy is weakening at a time that interest rates are already low.

Mr. Williams’s words carry great weight in markets, in part, because he is vice chairman of the rate-setting Federal Open Market Committee. After markets began anticipating the larger rate cut, the New York Fed issued a rare clarification that the speech hadn’t been intended to deliver a specific signal about near-term policy actions.

“This was an academic speech on 20 years of research. It was not about potential policy actions at the upcoming FOMC meeting,” said a New York Fed spokesman on Thursday evening in response to questions from reporters.

Mr. Williams, a leading academic thinker, highlighted points he has made publicly before. But the context of his remarks — he was speaking near the start of the Fed’s customary premeeting quiet period, which begins Saturday — fueled an unintended market reaction.

“We have not seen anything like this before and honestly, we are not sure what they were thinking,” said Neil Dutta, head of economics at Renaissance Macro Research LLC in a client note on Friday morning. “Of course the market would latch on to a speech like this — given focus and timing — right before the July confab.”

President Trump, who has been regularly calling for multiple rate cuts, said on Friday in a pair of tweets that he preferred Mr. Williams’s “first statement much better than his second.” He repeated his call for the Fed to cut rates aggressively: “Don’t blow it!”

Fed officials will have other developments to consider over the coming 10 days, including the European Central Bank’s policy decision next Thursday and reports on U.S. second-quarter economic growth and inflation.

Some officials who support lower rates have said they don’t think the Fed needs to make a big move right now. St. Louis Fed President James Bullard — who dissented from the June decision to keep rates steady because he favored a rate cut — said in an interview he would “listen to arguments” for a half-point cut but added, “Sitting here today, I just don’t think the situation really calls for that aggressive of a move.”

Dallas Fed President Robert Kaplan said in an interview Tuesday he could support a “tactical” rate cut because of recent declines in long-term bond yields, but that any such move should be “modest, restrained [and] limited.” He said he was worried about the potential to stoke asset-price bubbles by providing unnecessary stimulus.

Fed Vice Chairman Richard Clarida has repeatedly and approvingly cited examples from 1995 and 1998 when the Fed took out “insurance policies” by pre-emptively lowering interest rates when the economy still appeared healthy. In both of those cases, Fed officials initiated what would become a series of three rate cuts, in quarter-point intervals, over a few months.

If Fed officials draw from that playbook now, they would disappoint investors who have bet on a larger half-point cut, but officials would nevertheless hold open the possibility of additional cuts.

Ethan Harris, head of global economics at Bank of America Merrill Lynch, said a half-point cut and the broader themes Mr. Williams raised Thursday were more relevant to a situation in which the economy is clearly contracting.

“This shock-and-awe approach is the wrong tool for the problem at hand,” said Mr. Harris. “It’s not for when you’re facing a slowdown or a disappointment in hitting your inflation target.”

The case for a rate cut began building in May, after an escalation of trade tensions by Mr. Trump, first with China and later with Mexico. Surveys showed business sentiment soured, leading to worries about a stronger pullback in investment. “It was a bit of a confidence shock,” Mr. Powell said last week.

At the Fed’s June meeting, eight of 17 officials projected cutting rates this year, with seven of those eight expecting their benchmark rate would be a half-point lower by year’s end. The rate is currently in a range between 2.25% and 2.5%.

A larger cohort of 14 officials said they saw rising risks that growth would be weaker than expected, the most since the Fed launched its final round of bond-buying in 2012 to stimulate economic growth.

Lewis Alexander, chief U.S. economist at Nomura Securities, said given officials’ disagreements over whether and how much to cut rates it would be easier to reach agreement on a quarter-point cut than a half point. “If what you’re doing is signaling, there’s an advantage to having a stronger consensus, which sends a cleaner message,” he said.

Communicating the rationale for a larger cut could be tricky, because of the backdrop of relatively firm economic data, said William English, a former senior Fed economist who now teaches at Yale University. He said it made more sense to cut rates by a smaller increment now and hold out the possibility of additional moves later.

Other analysts have said economic weakness abroad will ultimately expose the U.S. corporate sector to a bigger slowdown that could sap domestic hiring, investment and spending, justifying more upfront Fed action.

“A strong policy response is necessary to arrest the recent sharp decline in economic momentum,” wrote economists at Morgan Stanley in a report calling for a half-point cut last week.

A rate cut is likely to also force debate over whether the Fed should curtail the runoff of its $3.8 trillion asset portfolio.

Fed officials had announced in March that the reduction in its holdings of Treasury securities would end in September, but Mr. Powell has also said they don’t want the runoff — a form of removing stimulus from the economy — to contradict with their rate policy, the primary way they aim to provide or remove stimulus.

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