Fed chair cements case for cut in interest rates

Fed chair cements case for cut in interest rates

Jay Powell, the chairman of the Federal Reserve, has cemented the case for the US central bank to cut interest rates based on mounting risks to the US economic outlook, in dovish testimony to Congress that could fuel expectations of a looming monetary easing. 

Despite a strong jobs report for the month of June and last month’s new truce in the trade war between the US and China, Mr Powell said “uncertainties about the outlook have increased in recent months”, particularly internationally. 

“Economic momentum appears to have slowed in some major foreign economies, and that weakness could affect the US economy. Moreover, a number of government policy issues have yet to be resolved, including trade developments, the federal debt ceiling, and Brexit. And there is a risk that weak inflation will be even more persistent that we currently anticipate,” Mr Powell said in prepared remarks.

Mr Powell’s statements to Congress were delivered as investors are betting that Fed monetary policymakers will move as early as late July to cut its main interest rate by at least 25 basis points from its current level of 2.25-2.5 per cent.

However, Mr Powell did not commit to any timeframe for possible monetary easing, nor did he point to the scale of the interest rate cuts that would be required to protect the US economy from the growing risks to the expansion. 

The Fed’s move towards looser monetary policy — potentially reversing the tightening cycle that Mr Powell oversaw in 2018 — comes as the central bank is under heavy pressure from US president Donald Trump, who has been openly pushing the US central banks to cut rates, drawing criticism that he is seeking to undermine the central bank’s independence. But the Fed has insisted that it is fiercely protective of its autonomy. 

The Fed began a serious debate about possible interest rate cuts at its last monetary policy meeting in June. Although it decided to hold off in order to garner more information, it signalled it would “act as appropriate to sustain the expansion”, setting the stage for a possible move.

“Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened,” Mr Powell said on Tuesday, referring to the June meeting.

“Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US economic outlook,” he added.

This suggests the Fed has little confidence that a new round of negotiations on trade between Washington and Beijing triggered after Mr Trump met Xi Jinping, the Chinese president, at the G20 in Osaka, could yield a lasting peace. 

The Fed’s consideration of interest rate cuts at a time of exceedingly low unemployment is being described by many economists as an “insurance” policy against a slowdown rather than a reaction to sharply worsening data, so it may only result in one or two cuts rather than a more protracted easing cycle.

One of the risks for the Fed in cutting rates now is that it could leave it less room to stimulate the economy once a new recession does come sometime in the future. 

In his testimony to Congress, Mr Powell said that the Fed’s “baseline outlook” was still that economic growth would be “solid”, with “strong” labour markets, and inflation moving up “over time” to its 2 per cent target.

The US economy grew at an annualised rate of 3.1 per cent in the first quarter, but Mr Powell said that pace had “moderated” in the second quarter, amid a slump in business fixed investment, housing investment, and manufacturing output.

Mr Powell also stressed “longer-run challenges” facing the US economy, from low prime-age labour force participation rates, to the stagnation of lower and middle incomes, adding to his relatively downbeat assessment of US economic prospects.

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