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Fed Now at Mercy of Trump Instead of Economic Reality

Fed Now at Mercy of Trump Instead of Economic Reality

Joel L. Naroff By Thursday, 01 August 2019 12:37 PM EDT Current | Bio | Archive

In a Nutshell: “In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate…”

Decision: Fed funds rate target range reduced to 2.00% to 2.25%.

As expected, but not universally agreed with, the Fed cut interest rates by 25 basis points - one-quarter point – for the first time in a decade. That occurred despite an economic statement that was the same as in June and an economy where the data have been better than expected.

So, why did the Fed reduce rates now? The key factors appear to be a fear of too low inflation that could lead to an extended, Japanese-style deflationary slump and worries about the world economy that were largely created by trade policy.

On the inflation front, it looks like inflation expectations are the key. Fed Chair Powell recognized that 25 basis points will not cure the problem of below target inflation. Indeed, it is fairly clear that a quarter-point cut will have limited economic impacts. But he believes that image matters and the reduction in rates and the end of the quantitative tightening process (which was also announced), should provide the confidence that inflation will ultimately move back toward target levels. I guess the Fed once again is putting its stock in jawboning, a strategy that hasn’t worked well in the past. He also noted that it might take longer to get back to target. That was likely noted so he can buy the Fed more time.

As for the world economy, the idea of cutting rates was to take out some insurance against a domestic slowdown induced by the trade issues. Of course, he did not indicate how a rate cut would accomplish that goal. That’s because it cannot.

As for future rate cuts, he hinted that this was the start of a process, but he tried to make it clear it would not be a long process. In other words, we should expect another rate cut, though it is not clear if that might happen at the next meeting or one a little later. Of course, if we keep getting solid data, who knows what this Fed will do.

So, what should we make of this move. The Fed has now become the economic mouth that is trying to roar. That is, he thinks that when the Fed talks, everyone listens. They do, but do they believe in what the Fed is saying? That’s unclear because rates are already low, global factors are beyond the Fed’s control and low inflation has been an issue for years now and small rate adjustments can accomplish very little.

But to me, the real problem is the markets. The Fed became the drug dealer of choice when it implemented and more importantly, sustained quantitative easing. But the junkies, i.e., the markets, are now controlling the drug dealer. When the markets get starved for more opiates, they scream and yell and ultimately, the Fed provides the drugs. It did that in two ways today, by lowering rates and ending QT early.

It is likely the markets will soon start demanding more. Indeed, the huge decline in the stock indices in the first hour after the announcement and during Mr. Powell’s press conference, as well as the rise in the dollar, seemed to say that one 25 basis point cut will not do it. As addicts will tell you, they can never get enough and the Fed is opening itself up to that potential problem, especially if the trade negotiations with China drag on.

If Mr. Powell wants to delude himself by continuing to make the argument that this is just a “mid-cycle adjustment,” then so be it. But he is now at the mercy of a mercurial president, foreign economies over which he has no control and economic/inflation perceptions rather than economic fundamentals.

As Oliver Hardy liked to say: “Well, here's another nice mess you've gotten (us) into.”

(The next FOMC meeting is September 17-18, 2019.)

Joel L. Naroff is the president and founder of Naroff Economic Advisors, a strategic economic consulting firm.

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Fed Chief Jerome Powell is now at the mercy of a mercurial president, foreign economies over which he has no control and economic/inflation perceptions rather than economic fundamentals.
fed, powell, rate, cut, trump
Thursday, 01 August 2019 12:37 PM
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