How a two-sided economy is dividing the Fed

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The last Summary of Economic Projections, released June 19, made it clear that not all members of the Federal Open Market Committee are on the same page.

Further evidence arose at the end of July when two presidents — Federal Reserve Bank of Kansas City President Esther George and Federal Reserve Bank of Boston President Eric Rosengren — dissented in the vote to cut rates to a range of 2% to 2.25%. Although dissents happen, these were the first in Jerome Powell's term as chairman.

powell-jerome-bl040814
Jerome Powell, governor of the U.S. Federal Reserve, listens during an open meeting of the Board of Governors of the Federal Reserve in Washington, D.C., U.S., on Tuesday, April 8, 2014. Federal Reserve Chairman Janet Yellen said today "considerable slack" in the labor market is evidence that the central bank's unprecedented accommodation will still be needed for "some time" to combat unemployment. Photographer: Andrew Harrer/Bloomberg *** Local Caption *** Jerome Powell

While the panel always features some hawks, some doves and some moderates, and therefore differing opinions, the rift has rarely seemed so wide.

“What is clear from recent speeches, the latest minutes, and the two dissents from the decision to lower rates last month is that the Committee is more divided now that it has been in quite awhile,” said Peter Ireland, a professor of economics at Boston College and a member of the Shadow Open Market Committee.

The economic picture remains two-sided, "with consumers going strong but manufacturing clearly suffering from trade and global economic uncertainty,” he said. “That gives participants on both sides of the debate ammunition to make their cases most effectively.”

Given this “mixed and uncertain outlook, … reasonable people will disagree,” Ireland said. “[T]here's clearly a firm consensus on the goals, just uncertainty about the appropriate steps to achieve them. In that sense, I think all this shows that there's room for healthy and productive debate and dissent within the Fed, which is a good sign.”

Certain factors make the current times unusual. “I think [the divide is] reflective of the relative uniqueness of the current situation: in spot terms, the economy by most measures is indeed solid, with low unemployment, above-breakeven job gains, inflation below but relatively close to target, and growth still above trend despite a likely closed output gap,” said Andrew Schneider, U.S. Economist at BNP Paribas. “At the same time, we’re in a context of extraordinary developments in trade policy, slowing global growth, and unprecedented attacks and pressure from the president, all within the larger context of a potentially new phase of monetary policy operating in a low r-star world with a flat Phillips Curve.”

And all these conditions make policy “very tricky right now, to say the least, and current conditions support arguments of both the hawks and the doves. In this sense, it would arguably be more surprising to have strong cohesion/consensus on the Committee under these circumstances.”

So, Fed Chairman Jerome “Powell's job to find a consensus that everyone on the Committee will find acceptable,” Boston College’s Ireland said, and in his speech Friday at Jackson Hole he’s like to “give some clues as to how he sees this consensus forming. My best guess is that he'll reinforce expectations for a second rate cut in September, but reinforce again that those cuts are ‘mid-cycle adjustments’ in response to the uncertain outlook and not the start of a prolonged easing cycle. Most of the recent data have come in stronger than expected, and the Chair will probably emphasize as a gesture to the hawks of the Committee that, especially if that trend continues, the next move after September could as likely be towards higher rates as towards lower.”

Bryce Doty, senior vice president/senior portfolio manager at Sit Fixed Income, called current circumstances unusual.

“Global weakness is being driven by trade disruption,” he said. “It’s telling how reliant the global economy has become on the U.S. consumer. When the U.S. shrugs, the rest of the world shudders. The CBO just estimated that tariffs would only shave off 0.3% of GDP for 2020 and a barely discernible 0.1% of GDP over the long term. While our trading partners will not be so fortunate.”

With inflation stuck between 1.5% and 2% and unemployment near 50-year lows, “the only reason to cut at this point is to prop up the stock market,” Doty said. “Essentially trade near-term market stability for longer term problems such as encouraging too much leverage and risk taking. (Just look at how the lowest investment grade bonds (BBB-rated) have doubled their weighting within the Aggregate Bond Index).

“So we can see why voting for higher rates isn’t a slam dunk for the Fed but I doubt they will have the intestinal fortitude to resist a rate cut in September,” he added. “Powell will likely forecast the cut tomorrow but the real question is will he signal that there will be more cuts to come this year or not. If not, stocks and bond yields will probably fall.”

“The FOMC minutes summed up the greatest concerns succinctly as weak global growth, trade policy uncertainty, and low inflation,” according to Marty Mitchell of The Mitchell Market Report. “Unfortunately for Powell and his FOMC colleagues, they don't have any control over global growth or trade policy, so those variables will continue to force the Fed to have a preemptive approach to warding off any potentially negative impact from those factors.”

George
Federal Reserve Bank of Kansas City President Esther George reiterated her view that there’s no reason to cut rates. Speaking on Bloomberg Television from Jackson Hole, Wyoming, she said, “depending on where you think you are in the business cycle, it can create more risk.”

Noting the global slowdown, George said: “Markets see how the rest of the world is slowing. I think uncertainty never plays well in the markets. So, I understand why you see fear and uncertainty right now. That isn’t the metric, though, that I feel we have to focus on. We have a clear mandate and, I think, a long-term view that we have to stay focused on.”

Harker
Federal Reserve Bank of Philadelphia President Patrick Harker, who doesn’t vote on policy this year, also opposed a rate cut, saying in an interview on CNBC, rates are near neutral. “I think we should stay here for a while and see how things play out.”

Leading Economic Index
The Leading Economic Index grew 0.5% in July, after dipping the two previous months, suggesting moderate economic expansion this year, The Conference Board said Thursday.

Economists polled by IFR Markets predicted a 0.2% increase.

Jobless claims
Initial jobless claims fell to 209,000 in the week ended Aug. 17 from 221,000 the week before, the Labor Department reported Thursday. Continuing claims declined to 1.674 million in week ended Aug. 10 from 1.728 million a week earlier.

Economists projected 216,000 claims in the week.

Manufacturing
Manufacturing in the Kansas City region contracted in August, as the composite index fell to negative 6 from negative 1 in July. "The month-over-month price indexes for raw materials and finished products decreased, turning negative for the first time since 2016," according to the Kansas City Fed's manufacturing survey. "Firms continued to expect prices to rise over the next 6 months, however."

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Monetary policy Economic indicators Jobless claims Jerome Powell Federal Reserve FOMC Federal Reserve Bank of Kansas City
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