The Fed Restocks the Punchbowl

Published on Jul. 30, 2019

The Fed Restocks the Punchbowl

If increasing interest rates is an action the Federal Open Market Committee (FOMC) undergoes seeking to reduce economic enthusiasm, especially to prevent the economy from overheating, then a rate cut is about keeping the party going.

And that’s what we have. Never mind that first half real GDP exceeded 2.5% (above the Fed’s forecast of 2.1% for the entire year) and that the health of the consumer and related spending impact upon the economy in recent months has been sound. Some recent data point to the potential for a solid second half as well. We’ll be interested in the Fed’s forward-looking language when they make their announcement. We doubt the Fed would explicitly set up the markets for continued easing, but their view on this is what we want to hear about.

It appears the Fed is looking out for the risks to the economy in making this insurance rate reduction. In our view, there are basically three risks.

First, the rest of the world is slowing or simply has no traction. While the U.S. consumer appears to be in good shape based upon consumer confidence, very low unemployment, and solid wage growth, other areas of our economy relating to manufacturing, exports, and housing have been weaker, and related data have been softer. Second, inflation remains stubbornly below the Fed’s 2% target. Last, trade policy is in flux, with significant risks of its own. These first two concerns are important markers for the Fed. The Fed does not want US policy to drift too far from the policies in the rest of the world, where central banks are also easing policy. The inflation story remains the Fed’s conundrum, they want to avoid disinflationary spirals. The Fed’s favorite inflation gauge, the core personal consumption expenditures measure (PCE), was 1.5% for the first half of the year. If inflation stays muted and if the economy falters, the Fed doesn’t have too much room to maneuver, but given four interest rate increases last year, the Fed has some.

For the Fed, the thinking is probably that any downside risks connected to uncertainty over global trade and a soft world-wide economic outlook could drag down US growth. At this point, the cost of easing policy is limited because inflation remains below target. It could be the case that an “insurance” cut is in order, after which the Fed will wait and see what the future holds with respect to the U.S. economy. This appears to be the market’s current expectation.

Leave a Reply

Subscribe to Our Insights Today

Roosevelt Investments