With an interest rate cut all but certain at this month’s Federal Open Market Committee meeting, the discussion has again turned to the magnitude.
The markets are pricing in slightly more than a 25 basis point cut. During a speech on Thursday, Federal Reserve Bank of New York President John Williams said when the feds fund rate target is close to zero “it pays to act quickly to lower rates at the first sign of economic distress.”
The markets interpreted this as a desire to cut rates by 50 basis points, and reacted accordingly, forcing the New York Fed to clarify that Williams was merely discussing academic research he’s worked on for 20 years, not potential policy moves at the upcoming meeting.
One of the most dovish members, Federal Reserve Bank of St. Louis President James Bullard said last month that a 25 basis point rate cut would be sufficient for now after he pushed at the last FOMC meeting for a cut.
But, in a research note, Morgan Stanley said, “a 25bp rate cut won’t be able to raise growth back above potential to help lift inflation expectations.” Such a move, it says, would have “a negligible impact on core PCE inflation,” and leave the 3-month/10-year curve inverted.
“Based on our reading of policy-makers’ previous comments on the yield curve, this suggests that a 25bp rate cut would not deliver the ‘somewhat more accommodative policy’ they are now aiming for.”
With the outlook “deteriorating” and not much space for the Fed to cut rates, “global shocks will likely have a more material impact on the U.S. outlook.” Morgan Stanley concludes “We think there’s a case to be made for a strong policy response.”
With the economy healthy, any rate cut is seen as “insurance” to keep the expansion continuing. Federal Reserve Board Chair Jerome Powell recently spoke of “uncertainties around trade tensions and concerns about the strength of the global economy” in suggesting the need for additional policy accommodation.
On Thursday, Bullard warned that “trade uncertainty is high, and I don’t see it declining any time soon.” In an interview on CNN International, he said, “This is going to be a volatile area of policy at least over the forecast horizon and possibly longer than that.”
Also on Thursday, Fed Vice Chair Richard Clarida said in an interview on Fox Business News, “you don’t need to wait until things get so bad to have a dramatic series of rate cuts.”
He said the Fed must decide where the economy is headed, and where the risks are. Although he repeated this contention the U.S. economy is “in a good place,” economic data for other nations has been weak. “Disinflationary pressures, if anything, are more intense than I thought six weeks ago.”
Consumer sentiment
The University of Michigan’s preliminary July consumer sentiment index rose to 98.4 from 98.2 in June, while the expectations index climbed to 90.1 from 89.3, and the current conditions gauge slid to 111.1 from 111.9.
The one-year inflation outlook dipped to 2.6% from 2.7, while the five-year inflation outlook rose to 2.6% from 2.3%.
