Why the Fed Cut Rates: To Try to Fix Last Year’s Mistake

There is less and less evidence to support the rationale for the earlier rounds of interest rate increases: that the economy was at risk of overheating and so higher rates were needed to forestall inflation. The unemployment rate has been at or below 4 percent for nearly a year and a half, yet prices continue rising more slowly than the 2 percent the Fed aims for. And if anything, growth in workers’ wages — the channel by which a tight labor market is expected to fuel inflation — has leveled out in recent months rather than accelerated.

It is becoming more clear than ever that we should not expect interest rates in the United States to return to their pre-2008 norms anytime soon. Consider that 30-year Treasury bonds are yielding only around 2.5 percent — implying that global investors with trillions of dollars on the line do not anticipate a quick end to the era of low rates.

So to make sense of what Mr. Powell and his colleagues did, don’t look for some particular data point that persuaded them interest rates were too high, or for an argument that slightly lower borrowing costs will unlock significantly more business investment or consumer spending.

Rather, think of it as a corrective action, aimed at undoing a mistake in 2018.

Unfortunately, that makes forecasting what the central bank will do next particularly tricky — and Mr. Powell’s news conference didn’t help matters.

He described the action as a “midcycle adjustment.” That fueled a stock market sell-off, as traders interpreted it to mean that there may not be the further rate cuts that have been reflected in asset prices.

Later, Mr. Powell added that he was not saying necessarily that this would be the only rate cut, only that it is not envisioned as the first in a long series of them.

This may be less of a communication failure and more of a genuine uncertainty within the Fed over whether to act again in light of solid economic data in recent weeks. Two Fed officials dissented from this week’s rate cut, so Mr. Powell could face a tricky task if he pushes for a further move later in the year.

Article source: https://www.nytimes.com/2019/07/31/upshot/why-fed-cut-rates.html?emc=rss&partner=rss