The Federal Reserve of the United States (Fed) responds to the promise launched to the market and in an unusual action proceeds to lower interest rates by a quarter point. It leaves them in a band between 2% and 2.25%. It involves a profound change of strategy, since es the first cut in the price of money since December 2008, when in the middle of the financial crisis it was virtually zero. This strategic turn is presented as a preventive adjustment to stimulate economic expansion at a time of uncertainty for Donald Trump's tariff war and with which he hopes to generate more inflation at the same time.
In addition, Jerome Powell, president of the central bank, advances the suspension of the balance sheet by two months, for this month of July instead of September as planned. This means that it keeps intact the debt assets accumulated during the crisis and ceases to part with them, which is currently around 3.8 trillion dollars.
It is the fifth time in the last 25 years that the rate hike in the United States has been reversed, to cut them. It is essentially a recalibrated, by way of insurance. Fed members telegraphed to the market in recent weeks why it made sense to take this step back in the normalization process, after seven months of pause. The only question was to know the intensity and if the door was to be left open for more discounts.
The statement explains that it was decided to lower the rates "in light of the implications of world evolution for the economic landscape, as well as the low inflationary pressure." He cites, in particular, the "persistence" of uncertainty and states that "it will act if it is appropriate to sustain the expansion, with a strong labor market and inflation." But the internal consensus is broken. The decision was rejected by Esther George, president of the Kansas Fed, and Eric Rosengren of Boston. They wanted to keep them.
Rate increases chained since 2015
The United States began raising rates at the end of 2015, with Janet Yellen as president. It was the end of an era of 0% rates in the United States. Then the neutral level – which does not ballast or reheat the economy – in the long term it was close to 5%. Jerome Powell gave continuity to the strategy by taking over a year and a half ago, with the labor market in full employment and rising prices. But inflationary fear did not materialize as expected and the weakness in prices combined with the moderation of global growth, commercial litigation and Brexit.
The Fed faced several dilemmas at this meeting. The market demanded the reduction being in historical maximums. Not having done it would not only have been tumultuous, it would have also reduced credibility for all the signs he had been giving. President Donald Trump pressed in parallel criticizing the latest increases while the other large central banks are immersed in a cycle of rebates.
Powell acts as a precaution. Something similar was done in 1995 and 1998, to avoid the recession. But this time the Fed is also a victim of its own message. After the last increase in December, he said that any decision would depend on the data. Neither the strength of the latest indicators nor the corporate results justified the cut. Nor is there a problem of credit availability, so it is doubted that it can stimulate growth in this way.
Weakness of inflation
The decision, therefore, was to be controversial. It wasn't a question about what he was going to do, but what he should. In addition, the market has already done half the work for the Fed when what is observed is the evolution of expectations. In November it was anticipated that the rates would reach 3% in 2019. Now they are below 2%. Persistently low inflation thus became the trigger to fire.
The members of the central bank have been justifying the cut with the price argument for weeks. Dallas Fed Chairman Robert Kaplan explained that inflation will remain low due to the vast changes caused by new technologies in the labor market. That, as Jerome Powell points out, broke the link between the evolution of wages and inflation over the past two decades.
The good progress of the economy and business, therefore, is no longer accompanied by a transfer in the rise in labor costs to the consumer through higher prices. That puts a hat on inflation and causes the neutral rate – the level that neither overheats nor burdens the economy – is lower. The Fed believes that the cut could now be enough to encourage activity and raise prices.
The potential growth of the US would be around 1.75%. It is expected that during the next quarters it will do so above 2%. Charles Evans of the Chicago Fed is also favorable to stimulating the economy. The combination of low inflation and increased uncertainty justifies two cuts before the end of 2019. Although it also says that you should not act in excess.
John Williams, president of the New York Fed, refers to studies that indicate that it is better to "act fast" and "preventively" than to wait for the "disaster." Vice President Richard Claridad believes that it is the right strategy. But at the same time, these studies indicate that it is important that all ammunition is not exhausted. Eric Rosengren, from Boston, warned of the cost.
The last three recessions originated in a bubble in the credit that the Fed helped form with monetary laxity. The mistake, therefore, could be repeated again and that can make the next recession even deeper. A half-point cut at this meeting would have also sent the signal that the US central bank is in a bearish cycle because it sees something more that damages the economy.
There are, therefore, no Fed precedents cutting rates in the midst of an expansion. The reduction can contribute, however, to relax the dollar. The appreciation of the greenback is a consequence of the commercial war and the strength of the economy. It also reflects the divergence between monetary policies. Trump complains that the European Central Bank is manipulating the euro to have a commercial advantage.
The Fed, therefore, needed to clearly communicate the arguments of its policy so as not to create the appearance of succumbing to the pressure. Wall Street anticipates a succession of sales, with a second adjustment in September and eventually another one at the end of the year. If the Fed members who want more inflation see that it still does not approach the target, it will be the signal that there will be more cuts from here on out.
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