This is an excerpt from our most recent Economic Outlook report. To access the full PDF, please click here.
The most recent rate cuts doled out by the Federal Open Market Committee (FOMC) mark a departure from traditional Fed policy (or any central bank policy, for that matter).
The U.S. Fed statutorily focuses on their dual mandate of promoting maximum sustainable employment and stable prices. Sustainable unemployment is usually defined as the highest level of U.S. domestic employment that can be maintained without adding to the risk of causing U.S. consumer inflation to rise above a +2.0% annual expected rate.
So, it does not appear consistent. Why did this patient need rate cuts? Indeed. Household unemployment rates remain at record lows. Yet, U.S. consumer inflation is nowhere near that 2.0% threshold. In past decades, Fed leaders remained apprehensive about premature policy action, based purely on expectations (critics might call it speculation) concerning future developments.
This time around, we stand witness to a policy approach that could be described positively as more holistic. It incorporates expectations (by Powell and 8 members of the FOMC) about how a broad global growth slowdown in aggregate demand can affect the U.S. economy’s future path. In particular, they worry about trade tariffs and a rise in other nationalistic tensions, which already weigh down capital investment made by U.S. businesses.
In June, Fed Chair Jerome Powell described his approach with an old adage about ‘an ounce of prevention being worth a pound of cure.’ What is his goal this time around? Preempt weakness in fundamentals by providing greater accommodation – well before the Fed board bears witness to actual regional U.S. slowdowns. He says there is a one-in-five chance that global problems lead companies to reduce employment in the U.S. or spook consumers into spending less.
Will his attempt be successful in slowing down a deceleration in U.S. GDP growth?
That depends on a number of factors, in our economist minds:
1) The preemptive nature of 2H-19 FOMC rate cuts appears as a more independent approach vis-à-vis past rate cut action. Prior decision-making was less driven by Fed Chair expectations. But that might not be the only thing that has changed. The responsiveness of the U.S. economy to Fed rate cuts, and to restarting a de facto “QE” policy, might have changed as well. In past years, the Fed’s money tap had led to an immediate increase in GDP forecasts by private sector economists. Recent decisions have not caused the same euphoria.
2) Long-term rates, more relevant to business activity and household spending (think about 30-year fixed mortgage rates) began their decline much sooner, in this record-long business cycle. They already have created fresh GDP growth.
3) Added to that, major U.S. corporations do not seem responsive to lower rates in terms of fixed business investment, given their reluctant stance towards new investment due to trade wars. Importantly, a decade long environment of accommodative monetary policy – topped with the most recent 2017 profit tax cuts – created an unprecedented amount of excess liquidity inside U.S. multinationals. This led to record share buybacks. Think about major companies like Apple being short of, or scared away from, tangible investment opportunities. Ultimately, it remains to be seen. Can a novel Fed policy be as potent as past accomodation? Or is this just serving up share index price stability in front of a U.S. election.
4) At the risk of sounding like we read too many Economist or Financial Times news articles, a successful conclusion of China trade negotiations remains paramount – to the ability of the U.S. economy to maintain its growth rate at current levels. A lack of trade negotiation success is not necessarily going to lead to a U.S. recession. But we think it will likely put a cap on U.S. real GDP growth rates much beyond +2.0% annually.
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