After delivering a split-decision rate cut earlier this week, US Federal Reserve officials put their divisions over the state of the economy and what should be done about it on full display yesterday with warnings of a slowdown and financial risks book-ending talk of how well things are going.
Central bankers may often be called on to speak with one voice, but the Fed now has three — those ready to reduce rates even lower to ward off economic risks, those ready to stand pat and watch the data for now, and those warning that the Fed may already be fuelling a credit bubble.
“The economy is in a good place,” Fed vice chair Richard Clarida said in a CNBC interview, noting that while there are risks, there is also a “virtuous circle” under way of job gains, wage gains, and increased spending among households.
Consumption accounts for nearly 70% of the US economy, and “I cannot think of a time in aggregate when the consumer has been in better shape,” Clarida said. That may be the case, but other Fed officials said the emphasis needs to be elsewhere — though they disagreed over just where.
Such disagreements are common at a central bank with 17 members approaching their analysis from different directions, 10 of whom get to vote on rates at any given meeting.
What’s unusual now is the crisp division and the reasons driving it, and the political context of a president who wants deep rate cuts for a wholly different rationale.
President Donald Trump, facing re-election next year, has lashed out at Fed policymakers with an array of sometimes personal insults, most recently calling them ‘boneheads’ and suggesting Chair Jerome Powell was an enemy of the state for not heeding his demands.
For Trump, who argues the US economy is the strongest ever, the logic is simple: cut rates to make it even stronger, with little or no risk.
But even those who agree with lower rates see the situation differently, with St Louis Fed President James Bullard arguing that the Fed should have cut deeper this week to ward off weakness that includes a manufacturing sector which “already appears to be in recession.”
Bullard dissented against this week’s Fed decision because he wanted a larger, half a percentage point rate reduction, and in a written statement said he feels overall economic growth may also slow “in the near horizon.”
“It is prudent risk management, in my view, to cut the policy rate aggressively now and then later increase it should the downside risks not materialize,” Bullard wrote. “Many estimates of recession probabilities have risen from low to moderate levels.”
The Fed by a 7-3 vote reduced its target overnight policy rate by a quarter of a percentage point on Wednesday, to a level of between 1.75% and 2.0%, to offset slowing global growth and risks associated with Trump’s trade battles with China.
It was the second Fed rate reduction this year. But it followed an even larger shift in the Fed’s policy outlook since late last year, when many officials expected they would still be raising rates this year.
Global growth and global bond markets started pushing in the other direction, however, opening a wide gap last spring and summer between the Fed’s policy projections and what investors anticipated would happen.
As a result of the change in rates and updated economic views, that gap has narrowed substantially, a positive development for a central bank whose top officials are being careful now not to flag what their next move might be until there is more information about the economy’s underlying health and direction.
After a spate of negative news over the summer, recent data has included positive surprises, including stronger-than-expected home sales, stock markets approaching new records, and a restart of US-China trade talks — a counter to Bullard’s more dire view.
Boston Federal Reserve President Eric Rosengren said the Fed should beware of feeding credit when the economy is humming. “Additional monetary stimulus is not needed for an economy where labour markets are already tight,” Rosengren wrote in a note explaining his own dissent from the Fed’s rate cut last week.
He came from the opposite end of the spectrum as Bullard, arguing for no rate cut at all.
In a challenge to Trump’s view that low rates are costless to the economy, Rosengren said current Fed policy is now actively nudging people to borrow and “risks further inflating the prices of risky assets and encouraging households and firms to take on too much leverage.”
This week’s meeting marked the first with three dissents since September 2016, when Rosengren joined two others in arguing for a rate increase.
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