On Standby:  Federal Reserve Positioning for Interest Rate Cut

        

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    Author: Adam Phillips

    In 1735, Benjamin Franklin penned an article for The Pennsylvania Gazette in which he suggested “an ounce of prevention is worth a pound of cure,” meaning preparing today for a potential crisis is preferable to reactive measures taken after an event has already occurred.  Although the quote originally referred to fire safety in his adopted hometown of Philadelphia, the same rule could apply to monetary policy in 2019.   

     

    After raising short-term interest rates nine times since it began normalizing policy in late 2015, it appears the Federal Reserve now believes a more prudent approach might be necessary as the U.S. contends with moderating economic activity stemming from ongoing issues including the trade war with China.

    Following their two-day meeting on Wednesday, the Federal Reserve voted to leave its benchmark interest rate unchanged while suggesting that a future rate cut could be warranted should the economy weaken in the months ahead.  In addition, Chairman Powell admitted in comments following the meeting that the case for a rate cut has strengthened in the weeks since the Fed’s last meeting in early May. 

    Preemptive Measures

    After months of debate regarding the need for a reduction in rates, a future rate cut is now seen as a foregone conclusion.  In fact, the bond market is now pricing in a 100% probability of a rate cut at the Fed’s next meeting in late July.  Meanwhile, short-term bond yields have declined in anticipation of the move, with the 2-year Treasury note falling from 1.86% just prior to the June 20 meeting to 1.76% by the end of the week. 

    With consumer spending up sharply in May and the unemployment rate at just 3.6%, it may be difficult for some to understand the need for policy accommodation at this time.  However, it is hard to deny that some indicators have softened over the last several months. For instance, after 10 years of economic expansion in the U.S., inflation remains anemic and well below the Fed’s 2% target.  In addition, the so-called “soft data” which includes confidence measures and manufacturing surveys suggests the economic toll of ongoing geopolitical uncertainty may continue to climb. 

    Therefore, an “insurance cut” by the Fed appears to be the most appropriate course of action at this time to provide breathing room for the economy should geopolitical headwinds linger or escalate in the months ahead.

    No Silver Bullet

    A rate cut by the Federal Reserve is likely to have a positive impact on the stock market over the near-term.  However, it is important to realize that accommodative monetary policy is only a temporary solution.  While one can argue that a rate cut buys the U.S. economy time as it awaits clarity on issues such as Brexit and the trade war, resolution will eventually be needed to restore business confidence and prolong the life of the current expansion. 

     

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