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>>> The Fed May Have No Choice But to Bail Out Trump


The stage is set for an interest-rate cut, but probably not until September.

Bloomberg

By Tim Duy

June 6, 2019


https://www.bloomberg.com/opinion/articles/2019-06-06/the-fed-may-have-no-choice-but-to-bail-out-trump


The U.S.-China trade war may force the Federal Reserve to cut rates.

Federal Reserve Chair Jerome Powell addressed nervous market participants this week by assuring them that the central bank “will act as appropriate” to keep the U.S. expansion on track. This wasn’t a signal that a rate cut is imminent. It was, however, a clear signal that the bar to lowering rates is fairly low. Considering the growing risks to the outlook, the Fed only needs a push to justify a cut. The push will likely come in the form of softer economic data, but could also be a severe bout of financial turmoil.

Fed officials have resisted sending signals about the direction rates, assigning equal possibilities of either an increase or a cut. The shifting balance of risks, however, make that an increasingly difficult story to sell. The escalation of trade wars from China to Mexico create substantial uncertainty for the outlook, and none of it good.

Some complain that the Fed would only be bailing out President Donald Trump in his ill-advised use of tariffs by cutting rates. Such charges will fall on deaf ears at the Fed. Policy makers may not like responding to Trump’s escapades with easier policy, but they ultimately have little choice but to do so. The Fed responds to shocks in a systematic fashion, even those created by the government. The Fed will respond to this shock with easier policy as they seek to sustain the expansion and meet their employment and inflation objectives.

Won’t the inflationary impact of tariffs stay the Fed’s hands when it comes to rate cuts? Most likely not. First, the Fed views tariffs as a temporary price shock expected to fade over time. They will look through any acceleration in inflation.

Second, Fed officials adhering to a symmetric price target will tolerate inflation overshoots to the same degree they tolerate undershoots. In practice, this means that just like they have not pursued an excessively easy policy to push the rate inflation back up to their 2% target, they will not pursue an excessively tight policy to push it back down. Going forward we may see a distribution of inflation outcomes centered above 2%. This would have the benefit of proving the Fed’s inflation target is in fact symmetric.

Third, the Fed will err on the side of caution. The Fed is well aware of the dangers of the zero bound in rates. I suspect that those dangers will lead them to conclude that the policy risks are very asymmetric. Their tools will prove more effective at pulling down an inflation overshoot in the future relative to stimulating the economy at the zero bound. There is much to be said for an insurance rate cut, especially at this challenging point in the business cycle where growth is slowing and companies worry that they should be retrenching in anticipation of the next recession.

The Fed, however, still needs to see greater evidence that growth is in fact slowing as forecast. Policy makers do not see large macro impacts from tariffs, which makes it difficult to justify substantial changes to the outlook on tariffs alone. Moreover, while we have seen some softness in the data, it is not excessive. The Institute for Supply Management’s manufacturing report for May showed that the sector was still expanding. The ISM’s services report, covering the much larger sector, revealed that activity, including hiring, accelerated in May.

In contrast, the ADP Research Institute’s employment report indicated that job growth slowed in May. A sustained slowdown in job growth would go a long way toward justifying a rate cut. The ADP number, however, is not always a reliable signal. The Fed will pay much more attention to the Labor Department’s employment report for May that comes Friday. But even there one weak number will be seen as an outlier, not a trend. The Fed typically needs a wider range of data to shift gears.

Although the stage is set for the Fed to cut rates, policy makers won’t have sufficient data to act until the end of the summer. A move at the September meeting is a reasonable baseline at this point. If the data deteriorate more quickly, or if markets seize up, pull that cut forward into July. If trade tensions ease and growth stays strong, push it back.

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