A divided Federal Reserve tries to do no harm
At their September meeting, Federal Reserve policymakers sent a message: first, do no harm. The Fed’s rate-setting committee on Wednesday cut interest rates 25 basis points — as expected. But otherwise, a deeply split central bank pushed back decisions on whether the US economy needs more monetary easing to cope with trade tensions — and on whether it will need to expand its balance sheet to prevent further disruption in the money markets. “When the direction is relatively clear, it’s relatively easy to reach unanimity,” said Jay Powell, Fed chairman. “This is a time of difficult judgments, as you can see, disparate perspectives.” By “disparate perspectives”, he meant that there had been three dissents at the meeting. Two Fed presidents — Kansas City’s Esther George and Boston’s Eric Rosengren wanted no cut at all. One — Jim Bullard of St Louis — wanted a larger one.
It is certainly possible that we will need to resume the organic growth of the balance sheet earlier than we thought
“The main tension the Fed faces is the economy has not really slowed,” said Ashok Bhatia, a deputy chief investment officer at Neuberger Berman. The unemployment rate remains at 40-year lows. Consumer spending remains strong. People have jobs and are buying things, the two necessary conditions for a thriving economy. One group at the Fed wants to be pre-emptive, said Mr Bhatia. Another group is arguing that nothing has happened yet. “That tension is why we’ve ended up at 25 basis points,” he said. The sticking point, he said, is trade. In both his prepared remarks and his answers to reporters, Mr Powell went into more detail than he has in the past on the real, observable effects that drawn-out trade negotiations have had on business investment. The Fed had been hearing from business owners around the country that they had delayed investments as they waited out trade negotiations. From the second-quarter report on gross domestic product, Mr Powell cited business investment numbers, which contracted slightly.Asked about a paper by the Fed’s Board of Governors that found as much as a whole percentage point of drag in GDP growth by the end of 2020 from trade uncertainty, Mr Powell praised the research, and said that other papers had found similar results. But he said precision was still difficult. “There’s real uncertainty around these effects,” he said. “It’s a $22tn economy. To try to isolate the effects of certain things is very challenging, but we do the best we can.”Mr Bullard, president of the St Louis Fed, has been openly worried about the effects of trade uncertainty. He wanted a 50bp cut. There appears to have been an argument in the committee over whether the Fed can know enough about the future effects of trade uncertainty to act decisively on it now. Mr Bullard seems to have lost that argument. Trade rhetoric has deteriorated since the last meeting. But the committee made minimal changes to its statement, and projections for the future showed no consensus on any more rate cuts through to the end of 2020. “There is not enough of a consensus for [Mr Powell] to commit to a clear path,” said Krishna Memani, vice-chairman of investments at Invesco. “Therefore he is trying to thread a needle.”The Fed offered a similar response to the disruptions in the short-term funding markets earlier in the week that had prompted the New York Fed to dust off its “repo” facility, a way of making short-term loans that the Fed uses to drive down borrowing rates. The Fed had not had used the facility in 10 years. The simplest explanation for the disruptions is that when banks do not have enough reserves at the Fed that they can use to easily lend each other money, short-term borrowing costs can spike. Mr Powell noted this week’s market disruptions, and said that though the Fed had expected short-term interest rates to rise briefly this week, the jump had been “a stronger response than certainly we expected”.He conceded, in code, that bank reserve levels might have been too low. Asked whether reserve levels were adequate, he said: “We’ve always said the level is uncertain.” He even hinted at a solution. When the Fed buys assets, it credits banks with reserves. “It is certainly possible that we will need to resume the organic growth of the balance sheet earlier than we thought,” he said. “That’s always been a possibility and it certainly is now. Again, we’ll be looking carefully in the coming days.”
Thursday, 19 September, 2019
But the committee and Mr Powell did not commit to asset purchases to increase reserves, or even to a more permanent repo facility, as some analysts had predicted they would. “I am disappointed,” said Priya Misra, head of rates strategy at TD Securities, “but think that the Fed just needs to do more work on this issue.”Ms Misra believes the Fed will know enough by its October meeting to commit to buying more assets. For now, the committee offered small, technical fixes to give it a little more room to manage short-term interest rates. So until October, it will remain a time of difficult judgments. And the Fed will wait and see.Andy Richman, director of fixed income at SunTrust Advisory Services, calls this “Powell’s conundrum”: there are real, visible risks to the future. But everything looks fine now.