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Fed Chairman Jerome Powell made a subtle move in that direction on Tuesday, dropping his standard reference to the Fed being “patient” in approaching any rate decision, and saying instead the central bank was watching fallout from the trade war and would react “as appropriate.”
The comment was a nod to what markets have been warning for weeks, and follows a substantial ratcheting up of trade tensions the Fed had, until recently, assumed would fade away soon.
“We do not know how or when these issues will be resolved,” Powell said. “We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labour market and inflation near our symmetric 2% objective.”
The brief statement opened a two-day session at the Chicago Federal Reserve intended to shore up the central bank’s policies to prepare for the near-certainty that policymakers will eventually confront another recession and push rates back to zero, eliminating any room to cut further and, as a result, exhausting a traditional policy tool.
The more immediate issue is how the Fed should respond to a trade war expanding on multiple fronts, after Trump slapped new 25% tariffs on US$200 billion of Chinese imports and threatened new import taxes on Mexican goods unless immigration slows. The question of how to respond divides policymakers and markets.
Powell did not call the Fed’s current 2.25-2.50% target interest rate appropriate, a standard talking point in recent Fed statements even as Trump has repeatedly blasted the Fed for raising rates last year and called for it to reverse course.
The Fed chairman’s comments come a day after St. Louis Federal Reserve President James Bullard said in a speech that a rate cut may be needed “soon.”
“We are likely seeing the beginning of coordinated Fed-speak to prep market participants for at least one rate cut this year,” said John Doyle, vice president of dealing and trading at Tempus Inc, a foreign exchange market specialist.
Yields on 2-year Treasuries, which are particularly responsive to investors’ forecasts about Fed policy, fell marginally when Powell spoke and were trading near their lowest levels in more than a year around 1.88%. The S&P 500 rose 1.8%.
Short-term interest rate futures imply the central bank will start cutting rates as soon as next month, as well as increasing fear that uncertainty about how the trade conflict will be resolved could push the United States and other economies into recession.
“We’ll look at market pricing,” along with a range of data on how the economy is doing, Fed Board of Governors Vice Chair Richard Clarida told CNBC on Tuesday. “Market pricing can go up and down so we can’t be handcuffed to that.”
Working on a new framework
Fed policymakers face conflicting signals. Government data shows that the U.S. economy has grown this year but markets point to significant risk of deterioration going forward.
Commerce Department data on Tuesday underscored that factory activity has weakened, with new orders for U.S.-made goods falling in April as shipments dropped by the most in two years.
Asked on Tuesday to interpret market expectations of rate cuts, Chicago Federal Reserve President Charles Evans told CNBC, “at face value it suggests that the market sees something that I haven’t yet seen in the national data.”
He said he sees rates as having been appropriate but that uncertainty and tepid inflation present risks worth monitoring. Over the long run, he said, policymakers may want to be more aggressive, using low rates to let inflation and economic momentum build.
That is among the considerations on the table at the Fed’s summit in Chicago, a continuation of meetings this year around the country involving academics, businesspeople and community leaders.
The Fed will consider how well it is prepared to meet the challenge of supporting the economy with rates at zero, including by buying bonds, as it did after the 2008 global financial crisis.
The Fed could also decide to temporarily welcome inflation a bit above its 2%-a-year target – and keep rates lower for longer – in the hopes that such a strategy will make the Fed’s goals for maximum employment and price stability more likely.
Policymakers are also revisiting exactly what maximum employment means and whether they are doing a good enough job in how they speak to the public. No changes are expected until next year.