By Steven K. Beckner
(MaceNews) – Those hoping for further aggressive credit easing by the
Federal Reserve or for an indefinite continuation of interest rate cuts are likely to be disappointed, barring a weaker than expected U.S. economic performance or some event that significantly darkens the economic outlook beyond what Fed officials now envision.
The Fed’s rate-setting Federal Open Market Committee may not be finished lowering the federal funds rate, but no one should get carried away in their expectations.
Many on Wall Street expect the FOMC will cut the federal funds rate to a target range of 1.5% to 1.75% at the end of this month, but that outcome is by no means guaranteed, based on what Fed officials are saying, publicly and privately.
Given the current outlook, the FOMC is likely to call at least a temporary halt to easing at some point — if not on Oct. 30 then before much longer. Calling it a pause might be something of a misnomer since, notwithstanding President Trump’s demands for a more aggressive series
of rate cuts, most officials foresaw little more than “insurance” or perhaps a “mid-cycle adjustment” when they started reversing some of their previous rate hikes on July 31.
Openly expressed Fed concern about the U.S.-China trade war and related uncertainties was a big reason for thinking Chairman Jerome Powell would forge an uneasy consensus on a divided Committee for what would be a third rate cut since mid-year. By implication, the “partial”
trade deal announced by President Trump Friday may make Fed policy-makers a bit less eager to ease monetary policy again.
What’s more, the Fed’s announcement Friday that it is resuming expansion of its balance sheet could make officials think twice about cutting rates so soon after its Sept. 16 move. Even though the Fed’s planned massive purchases of Treasury bills was advertised as purely
“technical” and “not a change in the stance of monetary policy” there are plenty of observers who do see the action as a kind of monetary stimulus.
The day before that, the Fed took steps to reduce capital and liquidity requirements for the biggest banks.
If nothing else, the optics of cutting rates a third time on the heels of the U.S.-China trade pact, a bold balance sheet expansion and a major liberalization of banking regulations might smack of Fed capitulation to White House pressure.
To be sure, global economic slowing, together with trade tensions and other geopolitical uncertainties, remains a concern for the Fed, but presumably not as much now that the U.S.-China trade war has been somewhat defused for now.
Senior Fed officials have made very clear that the outcome of U.S.-China trade talks, among other geopolitical developments, will have heavy influence on their assessment of the economic and policy outlook.The tit-for-tat tariff battle and related uncertainties were seen hurting exports, cooling manufacturing activity and stymieing business investment.
At the September FOMC meeting, the minutes reveal, concern was expressed by some participants that “uncertainties in the business outlook and sustained weak investment could eventually lead to slower hiring, which, in turn, could damp the growth of income and consumption.”
While there is plenty of wrangling yet to come between Washington and Beijing and while trade uncertainties have by no means been vanquished, Trump’s “very substantial phase one deal” would seem to give the FOMC a little breathing room.
It frees Powell and his colleagues to focus more on domestic economic conditions and prospects. Even the most “dovish” Fed officials do not dispute that the U.S. is well- situated. Or, as Powell reiterated last week, the economy is “in a good place,” even as he acknowledged “risks to this favorable outlook.”
Powell made the comments in wake of a mixed but largely solid September employment report, which in turn followed more discouraging purchasing managers surveys.
Fed officials of all stripes proudly point to “strong” labor markets.
They remain concerned that inflation, as measured by the price index for personal consumption expenditures (PCE), continues to run below the two percent target, but are relieved that it is closer to that target than it was earlier in the year and are aware that other inflation measures show inflation running at or above target.
Even before the events of late last week, there was a perceptible evolution in the mood of policy-makers — more of a sense of ambivalence about how much more monetary “insurance” the economy needs.
Having now cut the funds rate 50 basis points, undoing half of the 2018 tightening, Fed officials have become more cautious. Whereas before the July and September meetings, there was overt sentiment for easing, now there is more of an inclination to take a wait-and-see approach before cutting easier.
That approach was exemplified by Minneapolis Federal Reserve Bank President Eric Rosengren last Friday: “(A)fter two recent rate easings of 25 basis points each, monetary policy is already accommodative … . To me, it seems appropriate to continue to closely monitor incoming data to determine if the forecast of growth around potential is likely to be achieved, or if the risks … are indeed materializing.
“The economy has evolved about as expected, despite the unanticipated increase in tariffs and the slower growth of exports and business fixed investment,” Rosengren said. “Moreover, recent monetary policy easing is likely to provide some stimulus over the next several quarters.” He said the FOMC can afford to be “patient.”
Rosengren said he is “also alert to the possibility that recent escalations in trade tensions could moderate somewhat and this, in turn, might alleviate some of the downside risks to the U.S. and global economies.” So he said he will “avoid being rigid or predetermined from here,” but will “remain highly vigilant.”
Granted, it is not surprising Rosengren would make such comments as one of two bank presidents who voted against the last two rate cuts. But one hears similar comments from others, not all of whom can be quoted here.
Take, for instance, Dallas Fed President Robert Kaplan. Last Wednesday, the middle-of-the-road non-voter stated, “At this juncture, having adjusted the policy rate twice this year, it is my intention to take some time to carefully monitor economic developments. I am mindful of the potential excesses and imbalances that can be created as a result of excessive accommodation.”
And there are other, quieter voices. The general sense is that, notwithstanding global risks and uncertainties, the U.S. economy has done remarkably well and retains considerable momentum and that, the Fed has already taken out an appreciable amount of insurance to manage those risks.
There is still some time for policy-makers’ assessments to coalesce before the FOMC convenes, and they are headed into the meeting with more of an open mind than in recent months.
The Fed’s aim is to keep the economy rolling along, meeting or nearly meeting its “dual mandate” of maximum employment and price stability. The predominant view is that the FOMC has done a significant amount of easing to sustain growth and employment; that it may have to do more, but that it need not be in any hurry.
Policy-makers will also be assessing the prospective impact of the new mode of balance expansion. Just a couple of months after the Fed stopped shrinking its securities holdings by $50 billion, the Fed will be growing them by $60 billion per month.
The difference, of course, is that this time the Fed is buying short-term, not long-term securities, and the objective is not to push down long-term yields, but to provide enough reserves to meet demand to prevent the kind of spikes in short-term rates above the FOMC’s target seen since mid-September.
In addition to conducting large-scale, but temporary repurchase agreements to inject liquidity, the Fed will be expanding reserves on a permanent basis to regain control of the funds rate and other money market rates.
Powell, among others, was at pains to insist this is not a reprise of “quantitative easing.” The bill purchases “should in no way be confused with” Q.E., he declared.
But it cannot truly be said that the program will have zero monetary impact on financial conditions.
As it was explained by one knowledgeable person, “This balance sheet expansion is designed to accommodate a higher-than-they-expected demand for bank reserves, and it will not be sterilized. In fact they don’t want it to be. It should have a ‘monetary’ impact, but the impact that is expected is that, given the IOER and fed funds rate target, this will provide banks with the reserves to lend to the repo market to prevent repo rate spikes. So the monetary impact they are hoping for is to dampen upward movements in repo rates.”
If nothing else, the program should have the indirectly stimulative effect of relieving banks’ liquidity pressures and facilitating lending. New less stringent capital and liquidity regulations, which virtually coincided, also work in that direction.
What’s more, the bill purchases should have the salutary effect of steepening the yield curve, whose flat to inverted shape had been such a concern for many.