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Fed Could Mull Lower Rates if Inflation and Global Risks Worsen Fed May Consider Lower Rates if Inflation and Global Risks Worsen
(about 3 hours later)
Federal Reserve officials are confronting a series of economic risks that could prod them away from their patient stance and push them toward cutting interest rates. Growing economic risks from President Trump’s trade war with China could prod Federal Reserve officials away from their patient stance and toward cutting interest rates.
The central bank is grappling with low inflation — price gains have hovered below their 2 percent target for most of this 10-year-long expansion — at the same time as President Trump’s trade spat with China has intensified, rattling markets and presenting a threat to already-softening global growth. The central bank was already grappling with low inflation — price increases have hovered below officials’ 2 percent target for most of this 10-year expansion — when Mr. Trump’s trade spat with China intensified this month, rattling markets and threatening global growth. If those risks continue or intensify, they might persuade the Fed to consider taking steps to bolster the economy, including a potential rate cut.
Weakening price pressures or spillovers from a global economic slowdown could be enough to convince the Fed that it needs to take steps to bolster the economy. “If the incoming data were to show a persistent shortfall in inflation below our 2 percent objective or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook,” officials would take that into account in assessing whether interest rates should continue to remain unchanged, the Fed’s vice chairman, Richard Clarida, said during a speech in New York on Thursday.
“If the incoming data were to show a persistent shortfall in inflation below our 2 percent objective or were it to indicate that global economic and financial developments present a material downside risk to our baseline outlook,” officials would take that into account in assessing whether interest rates should stay on pause, the Fed’s vice chairman, Richard Clarida, said in New York on Thursday. Later, in response to a question, Mr. Clarida said that although the economy was in a good place, “if we saw a downside risk to the outlook, then that would be a factor that could call for more accommodative policy.”
Later, in response to a question, he said that “if we saw a downside risk to the outlook, then that would be a factor that could call for more accommodative policy.” Mr. Clarida is just one of 17 Fed officials — albeit an important one — and his remarks are hardly a battle cry for rate cuts, but they are a sign that the Fed’s top brass is watching global developments warily. The central bank has little to gain by signaling to investors that a policy change is imminent, because President Xi Jinping of China and Mr. Trump are expected to meet at a Group of 20 summit meeting in Osaka, Japan, late next month. Risks could quickly dissipate if they strike a deal.
The Fed left rates on hold after its April 30 and May 1 meetings, but that decision came against a backdrop of fading trade tensions and improving economic data. Talks between the United States and China have since collapsed, and Mr. Trump has ramped up his trade war by raising tariffs on $200 billion worth of Chinese goods while threatening to tax another $300 billion worth. But if the meeting does not produce a path toward an agreement, the Fed might find that it needs to respond.
Financial conditions have tightened markedly since then, based on a Goldman Sachs index. That is important because the Fed watches such gauges to get a sense of how market turmoil might feed into the real economy. A worsening in financial conditions toward the end of 2018 is, in part, what prompted the central bank to pivot away from gradual rate increases and toward a patient stance early this year. “If we’re on a bad track following the June G-20, we would expect that naturally to be accompanied by worsening business confidence and further tightening in financial conditions via equity markets and the dollar,” said Krishna Guha, the vice chairman of Evercore ISI. “It seems to me more likely than not that we would see rate cuts in the fall in that scenario.”
The renewed trade tensions come as global growth continues to weaken. Germany’s unemployment rate rose in May, data out this week showed. Australia’s central bank is downgrading its growth outlook and considering a rate cut, and in the United States some economic indicators, including durable goods orders and new home sales, have softened, even as job market readings hold firm. The Fed’s most recent decision to leave rates on pause — announced May 1 — came against a backdrop of fading trade tensions and improving economic data. Talks between the United States and China collapsed shortly after that, and Mr. Trump has since ramped up his trade war by raising tariffs on $200 billion worth of Chinese goods while threatening to tax an additional $300 billion worth.
Bond markets are increasingly betting on Fed rate cuts against that backdrop, and as inflation expectations show signs of weakening both in America and around the world. Financial conditions have since tightened, based on a Goldman Sachs index. The Fed watches such gauges to get a sense of how market turmoil might feed into the real economy. Worsening financial conditions toward the end of 2018 were, in part, what prompted the central bank to shift away from gradual rate increases and toward a patient stance early this year.
“I judge that, at present, indicators suggest that longer-term inflation expectations sit at the low end of a range that I consider consistent with our price-stability mandate,” Mr. Clarida said on Thursday. “They are watching how the financial market is processing the trade war, and I think that’s an important input into their processing of downside risks,” said Michael Feroli, the chief United States economist at J.P. Morgan.
The Fed’s preferred inflation measure showed that prices climbed 1.6 percent in the year through March, stripping out volatile food and fuel indexes. Fresh data will be released on Friday morning in Washington. If there is a second 2019 pivot, economists say, it could happen fairly abruptly.
“Your sense is that forward momentum in the economy is fine, but it may not be so strong that you would be willing to ignore survey and market indicators and wait until the hard data shows a big trade impact,” Mr. Guha said. “The fact that this is like the anti-1970s — the deep underlying concern is inflation that’s too low — that certainly has to lower the threshold for the Fed to cut rates.”
Bond markets are increasingly betting that rate cuts are coming as growth begins to slow in places like Germany and Australia and as inflation expectations move lower both domestically and abroad.
“I judge that, at present, indicators suggest that longer-term inflation expectations sit at the low end of a range that I consider consistent with our price-stability mandate,” Mr. Clarida said.
The Fed’s preferred inflation measure showed that prices climbed 1.6 percent in the year through March, stripping out volatile food and fuel indexes. The Fed aims for stable 2 percent gains, and wants to miss to the upside as often as it misses to the downside.
Fresh inflation data will be released on Friday morning in Washington.
While it is possible that the trade war could temporarily lift prices, the Fed is likely to overlook that as a one-off shock or could even welcome it. Lael Brainard, a Fed governor, recently suggested that the central bank could seize on what she calls “opportunistic reflation” to prove to investors and consumers that it is serious about getting price gains back to — and even, for a time, above — 2 percent.
In other words, an increase in import prices that pushes inflation north of the Fed’s goal would not prompt the central bank to offset that. That would prompt Fed watchers to understand that officials mean it when they say they are happy to tolerate higher price increases, and inflation expectations would creep back up.
“The Federal Reserve could use that opportunity to communicate that a mild overshooting of inflation is consistent with our goals and to align policy with that statement,” Ms. Brainard said in a speech this month.