Fed presidents say rate cut may be needed

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Two Federal Reserve bank presidents suggested Monday that growth may be slowing enough to prompt policy makers to consider an interest rate cut.

Federal Reserve Bank of St. Louis President James Bullard said conditions may “soon” warrant a rate cut, while Federal Reserve Bank of San Francisco President Mary Daly said the Federal Open Market Committee may need to consider lowering the target rate if growth slows or inflation fails to pick up.

Economic activity slowed to its lowest level since October 2016 in May, according to the Institute for Supply Management. The May PMI index fell to 52.1% from 52.8% in April, the lowest reading since 51.7% in October 2016, ISM said. Economists polled by IFR Markets expected a gain to 53.0%.

“Respondents expressed concern with the escalation in the U.S.-China trade standoff, but overall sentiment remained predominantly positive,” according to Timothy R. Fiore, chair of ISM’s manufacturing business survey committee. “The PMI continues to reflect slowing expansion.”

Prices rose to 53.2% in the month from 50% in April.

Inventories declined. “Many respondents noted that they are watching inventories closely and, in some cases, ‘managing down,’” the report said.

“A downward policy rate adjustment may be warranted soon to help re-center inflation and inflation expectations at target and also to provide some insurance in case of a sharper-than-expected slowdown,” Bullard told the Union League Club of Chicago on Monday.

Economic growth is slowing, and a trade war could worsen conditions, he said according to text released by the Fed. “Both inflation and inflation expectations remain below target, and signals from the Treasury yield curve seem to suggest that the current policy rate setting is inappropriately high.”

Daly said there’s not enough information on threatened tariffs on Mexico to determine what the impact will be, but, she added, other recent tariffs caused “small upward pressure” on inflation, according to news reports, but businesses have yet to pass on those costs to consumers.

If trade issues sharply slow growth, or don’t trigger a sustainable rise in inflation, the Fed would need to consider cutting interest rates, she told reporters.

The yield curve would have to invert more or longer for it to signal a coming recession, she said.

An escalation of the trade wars could send the U.S. into recession in as little as three quarters, according to Chetan Ahya, chief economist at Morgan Stanley. “[M]arkets are underestimating the impact of trade tensions,” according to a Morgan Stanley Research note from Chetan Ahya, chief economist.

If the U.S. imposes the 25% tariffs on the remaining imports from China and that nation counters, “the global cycle will be at risk” and a recession is less than a year away, according to Ahya.

Construction spending
U.S. construction spending was flat in April as public construction gains offset a fourth consecutive decline in private residential spending.

Economists projected a 0.3% rise. The Commerce Department revised the March spending figure to a 0.1% increase, from the 0.9% decrease initially reported.

Public construction rose 4.8% in the month, while private construction dropped 1.7%, to its lowest total since January 2017.

Replacing LIBOR
Fed Vice Chair for Supervision Randal Quarles, said LIBOR will be replaced. “Clarity on the exact timing and nature of the LIBOR stop is still to come, but the regulator of LIBOR has said that it is a matter of how LIBOR will end rather than if it will end, and it is hard to see how one could be clearer than that,” Quarles told the Alternative Reference Rates Committee, according to prepared text released by the Fed.

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