Money & Banking

Fed copies 1990s playbook in bid to avert a downturn

Reuters Washington | Updated on October 29, 2019

US Federal Reserve building in Washington   -  Reuters

A rate cut on Wednesday, which would be the Fed's third this year, would lower the overnight benchmark lending rate to a new range of between 1.5% and 1.75%.

In the midst of what became a golden decade for the US Federal Reserve, central bankers twice in the 1990s cut interest rates in short bursts that managed to help the US economy continue growing despite slowing investment and weak growth overseas. Today's Fed hopes a third time proves just as charmed.

In their latest two-day policy meeting this week, Fed officials look set to nudge the economy along in similar fashion with their third consecutive rate cut. That would match the moves made by then-Fed Chairman Alan Greenspan in 1995 and 1998 during an era known as “the Great Moderation” for its steady growth, falling unemployment and tempered inflation.

There's been no clear commitment to another reduction in borrowing costs from Fed Policymakers, though a failure to lower rates on Wednesday could risk upending financial markets that are confident another cut is coming. With billions of dollars in bets on futures markets tied to anticipated Fed actions, any deviation by the US central bank from the expected course typically leads to sharp swings in bond and stock markets.

A rate cut on Wednesday, which would be the Fed's third this year, would lower the overnight benchmark lending rate to a new range of between 1.5% and 1.75%. Policymakers may emphasize that ”the three cuts cumulatively have served to balance the risks to the outlook,” and will likely keep the economy on track, JP Morgan economist Michael Feroli wrote last week.

The Fed is scheduled to announce its latest policy decision at 2 pm EDT on Wednesday (1800 GMT). Fed Chair Jerome Powell will hold a news conference half an hour later. Policymakers likely won't shut the door to further action, but may “communicate patience in deciding future policy moves,” TD Securities analysts wrote last week.

Gaining leeway

Investors have no firm opinion on when the Fed will move again after Wednesday, a signal to Powell and his colleagues that if they deliver the expected cut this week they will have room to shape market expectations moving forward.

According to CME Group's FedWatch, the probability of a rate reduction on Wednesday stands at 94%. After that, however, it's a coin toss whether there will be any further change for at least a year.

That in itself is a success for Powell. Beginning last fall, the Fed confronted a widening gap between what Policymakers at that point thought would be continued rate hikes, and the expectations of investors who began factoring rate cuts into their outlook as a global economic slowdown took hold around the intensifying US-China trade war.

The Fed, under pressure to lower rates from President Donald Trump but also watching US investment and manufacturing data weaken, reversed course early this year. Financial markets have responded with largely easier borrowing conditions, and lower rates on important benchmarks like 30-year home mortgages. Key aspects of the bond market, watched by some Fed officials as evidence of faith or lack of it in near-term economic growth, have been looking steadily healthier.

Some of the ongoing problems like the trade war with China and the prospect of a disorderly British exit from the European Union also have lightened, at least a bit. That has helped narrow the gap between the Fed and global market expectations.

It may have helped narrow gaps within the US central bank as well. Even those Fed officials who have been most eager to cut rates now feel that one more quarter-percentage-point reduction should be adequate for the year.

Gross Domestic Product

Today's circumstances share a number of similarities with those confronting the Fed roughly a quarter of a century ago. In July 1995, Fed officials, as now, debated whether slower-than-expected growth would impair business investment, spilling over into hiring plans and, ultimately, household spending.

Just as weak growth in Europe is seen as a risk for US companies today, a weak outlook for Canada and Japan was a concern then, according to minutes of the meeting at which the Fed adopted the first of three rate cuts in six months.

“During the last six weeks my optimism has diminished,” said former Fed Chair Janet Yellen, who was president of the San Francisco Fed at the time. Without action by the Fed “we could easily end up, I think, in an extended growth recession.” Fast-forward to the present, and again the economic data has not been great.

The most recent jobs and retail sales reports were both weak. Economists polled by Reuters expect economic growth slowed in the third quarter to an annual rate of 1.7%, from a 2% pace in the second quarter. The advance estimate of gross domestic product is due to be released on Wednesday, before the Fed concludes its policy meeting.

As the 1990s proceeded, it took two such rounds of ”mid-cycle adjustment,” about two years apart and each involving three rate cuts of a quarter of a percentage point each, to keep that recovery on track. It was derailed by the bursting of the dot-com stock market bubble, with a recession starting in March, 2001.

The expansion since the 2007-2009 financial crisis and recession has already eclipsed the 1990s to become the most prolonged period of sustained growth in US history. While the pace has sometimes been tepid, Powell and his colleagues argue there is no reason it can't keep going, and have pledged to act “as appropriate” to try to make it so.

At a speech in Denver earlier this month, Powell nodded to both the risks facing the US economy, but also to its ongoing growth. On balance, “this feels very sustainable,” he said.

Published on October 29, 2019

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