By Steven K. Beckner
(MaceNews) – Ever since the Federal Reserve’s policymaking Federal Open Market Committee cut interest rates modestly for the first time in 11 years on July 31, financial markets have been eagerly waiting to see what Chairman Jerome Powell’s monetary policy posture would be three weeks later at the Fed’s annual Jackson Hole symposium.
They were hoping Powell Friday would lean more strongly toward another rate cut as soon as mid-September than he did in his post-FOMC press conference, when he left the impression with many that the 25 basis point rate cut was just a one-time “mid-cycle adjustment.”
President Trump has kept steady pressure on the Fed to slash rates, sometimes insulting Powell in the process. This week he called on the Fed to cut the funds rate at least a full percentage point, even while extolling how well the U.S. economy is doing.
But at best, it seems fair to say, Wall Street and the White House got half a loaf from the Fed chief, as he keynoted the Kansas City Federal Reserve Bank’s conference on “Challenges for Monetary Policy.”
True, Powell reiterated the Fed will “act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective.” But he stopped well short of sending the kind of aggressive credit easing signal many were hoping for.
Once again, Powell was noncommittal, telling the Jackson Hole participants further rate cuts will depend on how he and his fellow policymakers assess the economy and how it is likely to be affected by an array of domestic and international influences.
Not exactly what Wall Street or the White House wanted, but let’s face it – sending a stronger, clearer message would have been difficult for the Fed chief.
For one thing, it’s a tricky time for Fed policymakers. On one hand, above-trend economic growth has pushed unemployment near 50-year lows. Stocks have hit successive all-time highs. Though manufacturing and business investment have softened, consumer spending has remained strong.
On the other hand, trade tensions not seen since the 1920s have aggravated concerns about slowing global growth. As trade wars have spawned currency wars, marked by considerable dollar appreciation, the Fed finds itself operating in an increasingly fractious and unpredictable global environment.
Further complicating the picture is an often inverted, but hard-to-read yield curve.
Delving into this melange with evident trepidation, Powell gave a essentially balanced picture of the economic picture. For now, he said, the outlook is “favorable.” Although business investment and manufacturing “have weakened,” he said “solid” job growth and rising
wages are driving “robust” consumer spending.
Also, significantly, he observed that inflation “appears to be moving back up closer to our symmetric 2% objective,” although he said “there are concerns about a more prolonged shortfall.”
Powell said trade policy uncertainties are contributing to a global slowdown as well as market turbulence, but said the FOMC will have to assess how those factors are affecting the domestic economy when they meet next month to set rates.
He stipulated that trade policy-related uncertainties present an unprecedented “challenge” to the Fed, for which there is no “settled rulebook.”
“We can, however, try to look through what may be passing events, focus on how trade developments are affecting the outlook, and adjust policy to promote our objectives,” he said.
Not very satisfying for those eager to see radical rate cutting, perhaps. But realize it would have been out of character for the collegial Powell to prejudge the outcome of future FOMC meetings or to pre-commit his colleagues to a policy course. Pressure from Trump doesn’t make it any easier for the head of the independent central bank.
Divisions and uncertainties among Fed officials make it even trickier to front-run the Committee, whose next meeting is Sept. 17-18.
When the FOMC cut the federal funds rate 25 basis points to a target range of 2.0% to 2.25%, two of the voting Federal Reserve Bank Presidents – Kansas City’s Esther George and Boston’s Eric Rosengren – dissented. And they haven’t changed their tune since.
Explaining her “no” vote after the July decision, George said, “incoming economic data and the outlook for economic activity over the medium term warranted no change in the policy rate.”
George acknowledged “risks to the outlook as the economy faces the crosscurrents emanating from trade policy uncertainty and weaker global activity,” and said she “would be prepared to adjust policy” if “incoming data point to a weakening economy.”
But for the time being, George saw the moderation of economic growth that had taken place so far in 2019 as “in line” with her outlook for “a gradual decline” of GDP growth to trend. So, she said, “With moderate growth, record low unemployment, and a benign inflation outlook, maintaining the Committee’s policy settings at 2.25-2.5 percent would have been appropriate, in my view.”
Interviewed in Jackson Hole on the eve of Powell’s keynote address, George again conceded “concerns (and) uncertainty around trade,” but added, “it’s too soon to judge how the real economy is going to be affected.”
Rosengren explained his dissent by saying, “With the unemployment rate near 50-year lows and inflation likely to rise toward the 2 percent target, and with financial stability concerns being somewhat elevated given near-record equity prices and corporate leverage, I do not see a
clear and compelling case for additional monetary accommodation at this time.”
More recently, Rosengren made clear he hasn’t changed his views, saying, he “just want(s) to see evidence we are going into something that is more a slowdown” than the moderation of growth seen thus far.
It seems likely that George and Rosengren, who are focused more on financial stability and the cyclical status of the domestic economy and less on external woes, undershooting inflation and
yield curve inversions than many of their colleagues, will vote against lower rates next month.
Even among those who supported the July rate cut, one does not sense a great deal of eagerness to slash rates further – certainly no strident aggressiveness.
St. Louis Fed President James Bullard, who went so far as to dissent when the FOMC did NOT cut rates in June and voted with the majority to lower them late last month, took a cautious approach to further easing the following Tuesday (Aug. 6),
Bullard said the FOMC “bought some insurance against the deleterious effects this (trade war with China) might have on economic growth” and now needed to wait and see what more might be needed.
“We’ve already adjusted for the fact that trade uncertainty is going to be high; we have put in a more accommodative policy; now we’ll see if we bought enough insurance.”
Chicago Fed President Charles Evans, who also voted to cut rates, sounded only slightly less non-committal: “You could take the view, as I have, that inflation alone would call for more accommodation than we put in place with just our last meeting,” he said, but noted the economy’s fundamentals remain “good.”
“You might take the view that things have perhaps created more headwinds against that, and it would be reasonable to do more … . I don’t know,” Evans went on, but said he’ll be keeping a close eye on incoming data.
Among the broader FOMC membership, minutes of the July 30-31 meeting confirm both the differences in opinion and a desire to see more evidence of the need for additional accommodation. But they also reflect a realization that crucial financial conditions were as supportive of economic growth as they were because markets had priced in a certain amount of Fed easing.
Financial conditions were “premised importantly on expectations that the Federal Reserve would ease policy to help offset the drag on economic growth stemming from the weaker global outlook and uncertainties associated with international trade as well as to provide some insurance to address various downside risks,” the minutes say.
Despite the dissents and divisions, the FOMC majority clearly has an implicit, albeit contingent, bias toward additional easing, as the minutes make plain in their three-part list of reasons for cutting rates:
First, while the overall outlook remained favorable, there had been signs of deceleration in economic activity in recent quarters, particularly in business fixed investment and manufacturing. A pronounced slowing in economic growth in overseas economies – perhaps related in part to developments in, and uncertainties surrounding, international trade – appeared to be an important factor in this deceleration. More generally, such developments were among those that had led most participants over recent quarters to revise down their estimates of the policy rate path that would be appropriate to promote maximum employment and stable prices.”
“Second, a policy easing at this meeting would be a prudent step from a risk-management perspective. Despite some encouraging signs over the intermeeting period, many of the risks and uncertainties surrounding the economic outlook that had been a source of concern in June had remained elevated, particularly those associated with the global economic outlook and international trade. On this point, a number of participants observed that policy authorities in many foreign countries had only limited policy space to support aggregate demand should the downside risks to global economic growth be realized.”
“Third, there were concerns about the outlook for inflation. A number of participants observed that overall inflation had continued to run below the Committee’s 2 percent objective, as had inflation for items other than food and energy. … Most participants judged that long-term inflation expectations either were already below the Committee’s 2 percent goal or could decline below the level consistent with that goal should there be a continuation of the pattern of inflation coming in persistently below 2 percent.”
But an implicit bias does not necessarily translate into multiple rate cuts, as Trump and others would like to see.
First up was a paper by San Francisco Federal Reserve Bank economist Oscar Jorda, with input from former Fed Chairman Ben Bernanke and others, which confronts the modern reality that it is becoming increasingly difficult for the Fed to make monetary policy strictly along domestic lines, even though the U.S. is much less externally oriented than most.
With the Fed maintaining a substantial interest rate premium over the Euro area, among nations, “policy divergence” is a growing concern, note Jorda and co-author Alan Taylor of the University of California-Davis.
As central banks strive to stabilize inflation and smooth out the business cycle, they have to decide to what extent their monetary policies will be driven by domestic versus international forces. So the presenters distinguish between “on the one hand, how central banks steer by tightening and loosening their stance in response to local cyclical macroeconomic conditions; and on the other hand, how wider forces can permeate interest rate settings through the drift of the natural real rate of interest, or r*, at both local and global levels.”
Recalling Powell’s speech at last year’s Jackson Hole symposium, when he talked about the challenges of guiding policy with reference to r* and the “natural” unemployment rate or u*, Jorda and Taylor called that approach “navigating by the stars” or “celestial navigation.”
Conversely, a central bank “using only local cyclical conditions for pilotage would be akin to navigating by nearby clues like landmarks” or “terrestrial navigation.”
In reality, they say, both methods have to be used.
Jorda and Taylor argue that the Fed and other central banks should pay particiular attention to deviations of the policy rate (the funds rate) from the natural or “neutral” short-term rate (r*). ”
“If the neutral rate of interest declines faster than the central bank cuts nominal rates, financial conditions will be tighter, even if, on the surface, the central bank appears to be loosening them,” they warn, echoing precisely the kind of argument that more dovish Fed officials have been making for some time to justify funds rate cuts.
But central banks can’t look just at rates in their own countries, they contend. “In a financially integrated world where capital can move freely across borders with increasing ease, central banks should tack in response to local conditions while at the same time observing the drift of economic currents implied by disturbances in the neutral rate near and far. Ignoring such trends risks provoking internal and external imbalances, as well as unwanted dislocation in credit markets, eventually carrying the economy off course.”
In the current climate of mounting “anxieties about the negative spillovers and stresses that non-coordinated policy divergence might place upon the system,” Jorda and Taylor acknowledge that the Fed and its fellow central banks have tough choices to make.
On the one hand, they stress that “a direct comparison of interest rates across countries is too coarse a measure of monetary policy divergence or lack of monetary policy coordination … . (T)he monetary policy stance only makes sense in reference to the neutral rate prevailing in the economy. In addition, an economy’s neutral rate cannot diverge from the global neutral rate given the levels of real and financial integration characterizing modern economies.”
But while a central bank’s primary duty is “to protect the economic and financial welfare of its citizens,” it must be internationally minded as well, they say. “In a globalized economy with low rates of growth, low neutral real rates of interest, and tight financial integration, carrying out that duty will inevitably require central banks to adopt a global perspective.”
Equally relevant at a time when emerging market countries are being buffeted by interest rate and exchange rate swings among the industrialized nations was a paper by University of Maryland Professor Sebnem Kalemli-Ozcan showing how monetary policy spillovers from the U.S. to the rest of the world operate through changes in risk premia.
“This risk channel implies larger effects on EMEs than AEs due to EMEs country-specicific risk,” he notes, adding that “U.S. monetary policy changes have large spillover e ects on EMEs … . These spillovers manifest themselves through capital flows, domestic borrowing conditions, and movements in exchange rates and UIP deviations … .”
Kalemli-Ozcan says “a stronger dollar also weakens the balance sheet of currency-mismatched borrowers around the world,” and “this can result in financial spillovers to such borrowers and their home economies.”
Fed officials have long acknowledged that their policies affect emerging markets, but have largely contended that the global economy gets more benefit than harm from U.S. monetary policy. And they have advised other countries to adopt flexible exchange rate regimes.
The presenter concurred: “The case for flexible exchange rates is stronger in a world of international risk spillovers since exchange rate adjustment can smooth out shocks to risk sentiments. Trying to limit exchange rate volatility can be counterproductive as this policy response requires a large increase in domestic interest rates, turning a nominal exchange rate volatility into real output volatility in terms of lower GDP growth.”
Finally, at a time when the Fed is trying to refine its monetary policy communications and reassessing its whole policy framework, the Jackson Hole participants heard from former Federal Reserve Board staffer Athanasios Orphanides on central bank communication.
Orphanides, former president of the central bank of Cyprus told his former Fed colleagues, “Monetary policy is most effective when it is formulated in a systematic manner, following a clearly communicated monetary policy rule.”
“Even with the best intentions, discretionary policy worsens policy tradeoffs and yields inferior economic performance over time,” the current MIT professor continued. “In an environment of uncertainty, the rationale for discretionary policy decisions may be misunderstood. Discretion may invite perceptions of political interference that damage the credibility of the central bank and threaten its independence.”
At a time when Trump pressure on the Fed has called into question the Fed’s independence and credibility, Orphanides also said “a systematic monetary policy framework that is clearly communicated and well understood protects against such threats.