federal reserve

Decoding the Fed’s Interest Rate Cut

As ever, Jerome Powell is on the hot seat. Photo: Andrew Harrer/Bloomberg via Getty Images

Ben: The Fed announced that it would cut interest rates by a quarter point today. What is it hoping to accomplish with this adjustment, and why did stocks fall after the news was announced?

Josh: Stocks fell after the announcement but they rebounded through and after Fed chair Jay Powell’s press conference, ending up actually a little higher than they’d been before.

I think stocks fell because the announcement was more hawkish than market participants had expected. Ten of the 17 participants on the Federal Open Market Committee indicated they did not think an additional rate cut would be appropriate this year. The expectation had generally been that we’ll get one more rate cut, in December, so that divide on the committee was a surprise and you saw bond yields rise, as investors adjusted to the significant possibility this was the last rate cut of the year. Less expected easing of interest rates tends to be negative for stocks.

But then the market rebounded, I think in part because Fed chair Jay Powell sounded marginally more dovish at the press conference than in the statement. He was not very dovish though: He stubbornly refused to tip his hand about whether the Fed would cut rates a third time later this year, emphasizing that the Fed will make an appropriate decision based on the economic and financial information that’s available at the time.

I think partly he’s keeping his options open because the economic outlook could change, in either direction. Maybe growth worries will ease and inflation signals will pick up in the next three months, and he’ll have an easy case to make about why the Fed isn’t cutting again. Or maybe troubles will increase and a cut will be obviously correct. He’s right that he can’t exactly predict now what will be appropriate in December.

On the other hand, he may need to keep his options open simply because the committee is divided. He doesn’t just speak for himself, he speaks for the whole organization that has to make decisions together. And today’s decision had dissents in both directions for the first time in six years. One regional Fed bank president wanted to cut rates by a half point instead of a quarter; two others didn’t want to cut rates at all.

It’s harder to make commitments on behalf of a group where you don’t know what you’ll be able to get its members to agree to.

Ben: President Trump quickly attacked Powell, tweeting: “Jay Powell and the Federal Reserve Fail Again. No ‘guts,’ no sense, no vision!  A terrible communicator!” Trump wanted the Fed to cut rates to zero or even beyond. His views on this issue have not been as outlier-ish as in other areas; is there a case to be made that he’s right here?

Josh: There are two separate complaints here that I think should be considered separately. On “no guts, no sense, no vision,” Trump basically means the Fed should be cutting rates more. There are people who agree with him on this (including St. Louis Fed president James Bullard, who’s a voting member of the FOMC and dissented from today’s decision and said the cut should have been a half-point).

The argument for this view is essentially that inflation remains below target and the labor market is not as tight as it looks (the unemployment rate is low but that doesn’t count people out of the labor force who could be drawn back in if the job market were hotter) so the Fed is not meeting its dual mandate of full employment and stable prices, and would better do so by cutting rates more.

A related argument is that the economy faces risks that are suppressing business investment and a bold move by the Fed — a big rate cut — would boost confidence and investment and quite possibly avoid the need to cut rates more later.

His other complaint is about Powell “a terrible communicator.” He could mean a couple of things here. Investment manager Josh Brown was speculating on CNBC that Trump simply finds Powell to be boring — that he wishes he were more captivating on television. Maybe Trump thinks his statements would then have more positive effects on the market.

Ben: I for one kind of want my Fed chair to be boring.

Josh: But the other problem with Jay Powell’s communication is he’s sometimes been unclear. We especially saw this last December, when Powell spooked markets by sending a signal that the Fed was likely to keep raising interest rates even if the markets continued to weaken. It quickly became clear Powell had not meant to send such a strong signal in that direction and he had to make more statements to clean up his mess. All those comments moved the markets around a lot in a way Powell had not intended.

Fed chairs used to do four press conferences a year, but Powell has increased that to eight, one after every FOMC meeting. That gives him more opportunities to accidentally send the wrong signal to the markets through his comments. But it seems like he has gotten more careful. Powell is speaking more repetitively, leaning on talking points like that the Fed will be “data dependent” — that is, he can’t tell you now exactly what they’ll do about rates because it depends on what happens in the future. Today’s press conference was quite boring — as it should be.

Ben: In his remarks, Powell cited trade as one area of global instability, in his mild way — he said that “trade policy tensions have waxed and waned,” and spoke of “elevated uncertainty.” Can this be read at all as a rebuke or warning to Trump, or is he just stating the facts of the matter?

Josh: Powell certainly hopes it is not read as a rebuke about Trump. This is a topic about which he’s been clear and consistent — the Fed is not responsible for trade policy and it doesn’t say which trade policies are good or bad. But it does take into account how trade policy changes will affect the economy, and those effects on the economy may change the proper course of monetary policy. Specifically, he noted that trade policy disruptions appear to be discouraging business investment and manufacturing output. Those are some of the weakness aspects that have put rate cuts on the menu.

Ben: Would you say that today’s decision changes the short-term economic outlook in any substantial way?

Josh: Not a great deal, no. I think today’s statement made clear a third rate cut is somewhat less likely than we thought. But I also think we were never likely to get more than three rate cuts (assuming economic performance remains about where it is). Powell keeps referencing past “mid-cycle adjustments” from 1995-96 and 1998 as models for what the Fed is trying to do with this round of rate cuts. In each of those two prior cases, there was a total of 75 basis points worth of rate cuts, equivalent to three of these 25-basis point cuts.

Ben: Lastly, do you think Trump’s harping on how the Fed is blowing this is at all effective, either in terms of changing the agency’s thinking or in terms of letting himself off the hook for economic problems he helped create?

Josh: I don’t think so. As I’ve written a few times, if you look at when the Fed has changed its stance over the last year, it appears to have been reacting each time to either market turmoil or economic events. To the extent the president has been moving Fed policy, he has been doing so by causing economic events — that is, by ratcheting up the trade war in a way that harms the economic outlook.

As for whether it’s effective in convincing people that economic problems are someone else’s fault, I don’t know, but I doubt it. People care a lot about interest rates, inasmuch as they care about mortgage rates. But I don’t think that many voters closely follow the Fed and understand how independent it is from the president. Historically, presidents get excessive credit and blame for economic performance and I suspect that remains true.

Decoding the Fed’s Interest Rate Cut