Federal Reserve Chairman Jerome Powell was caught between a rock and a hard place. If he refuses to obey Donald Trump, he would be condemned. If he obeys his boss, he would be a puppet of the U.S. president. So when he took the middle way, cutting the key interest rate as desired by Trump, but only a quarter point, all hell breaks loose.

 

The interest rate cut, the first time since the 2008 Great Recession, was highly anticipated, although it happens during a weird time. The last time it was cut, the economy was plagued with deep financial crisis. Now, it was cut during a booming economy. Essentially, the rate cut, now set to hover between 2% and 2.25%, is to cater for the “future recession”.

 

The rate cut follows months of pressure from President Donald Trump, who has broken with past presidents’ practice of separating the central bank from politics. Trump, on the other hand, has been lecturing the Federal Reserve on how to do their jobs. So when the president did not get his candy, he slammed Powell of “letting us down”.

The Dow Jones fell as much as 478 points, but ended down 333 points, its worst day since May. Trump immediately launched his tweets – “What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle, which would keep pace with China, The European Union and other countries around the world.”

 

“As usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place – no inflation. We are winning anyway, but I am certainly not getting much help from the Federal Reserve!” – Trump continued his attacks on the poor Federal Reserve Chairman who refused to kowtow completely to him.

 

Apparently, the stock markets, and Trump for that matter, were not happy with the language used by Powell. The traders and investors were expecting a bigger rate cut, at least 50 basis points, and three rate hikes this year. But Powell gave them half of what they expected and a disastrous statement that the Fed’s action was a “mid-cycle adjustment to policy”.

Powell’s statement does not guarantee that more cuts are coming, let alone any indicative that more aggressive cuts would happen. Powell explained during his press conference that he meant that the Fed was not embarking on a long rate-cutting cycle, like one in a recession. He said – “Let me be clear: What I said was it’s not the beginning of a long series of rate cuts.”

 

Ward McCarthy, a Jefferies chief financial economist, said – “The policy statement was ambiguous and frankly he hasn’t done anything to clarify it. He seems like he’s not confident. My take is they’re worried about downside risks. His comments suggest this is not the beginning of a major easing cycle and that’s what hammered the market.”

 

But the Federal Reserve has been facing the unusual task of explaining why it was cutting rates in the face of stronger economic data. The unemployment is at a 50-year low and wages are slowly rising and inflation is low, as what Trump always boastfully tells all and sundry. On top of that, the Fed has to prove that it operates independently of the White House.

That explains why the policymakers voted only 8-2 in favour of a small cut in the federal funds rate. Boston Fed President Eric Rosengren and Kansas City Fed President Ester George disagreed with the move to cut the interest rate. That’s because since the Fed’s last meeting in June, the job gains, retail sales and economic growth have been stronger than expected.

 

Trump wants to make America more competitive with rivals such as China and allies in Europe. Accusing those countries of manipulating their currencies – including via lower interest rates – in a bid to grab export markets, the U.S. president wants Powell to follow what the rivals did. However, the Fed has its own concerns that the president may not realise, or deliberately doesn’t care.

 

The Fed was afraid of the risk that lower rates will lead to asset bubbles and excessive borrowing that will haunt the economy later. If the Fed uses its limited ammunition now, while the economy is still strong, it would be powerless later on if the economy turns bad. With the interest rate between 2.25 and 2.50 before the cut, it doesn’t take a genius to see why the Fed has limited firepower.

Rarely has the Fed cut rates before the economy looked set to spiral downward, but Federal Reserve Chairman Jerome Powell managed to scrape the bottom of the barrel, using trade uncertainties and a slowing global economy as a reason to cut the interest rate. He has said prior to the cut that the Fed is willing to make an “insurance cut” to protect the economic expansion.

 

Perhaps it’s not all rosy in the U.S. economy. Mr. Trump’s US$1.5 trillion tax cut is waning and businesses report that they are holding off on expanding, in part because of concern about global economic growth and a protracted trade dispute between the United States and China. As the 2020 Presidential Election nears, Trump wants to inject steroid into the current economic expansion.

 

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August 1st, 2019 by financetwitter

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