Fed Eases Toward Easing

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By Charles Tan - June 20, 2019

Within a six-month period, Federal Reserve (Fed) monetary policy has shifted from tightening to pausing to potentially easing. Although the central bank left its short-term interest rate target unchanged yesterday, the Fed signaled that a rate cut would remain in play if the economic outlook weakened. Charles Tan, senior vice president and co-CIO of Global Fixed Income, explains the Fed’s sentiment shift.

Q. What caused the Fed’s year-to-date change of course?

Charles Tan: In retrospect, the Fed’s December 2018 rate increase and its call for two rate hikes in 2019 were too bullish. This became clear in January, when the Fed abruptly halted its rate-hike campaign and outlook amid slowing global growth, muted inflation and sharp financial market volatility. Since then, we’ve seen further indications that global growth is slowing.

Additionally, the trade conflict between the U.S. and China has escalated, and new tariffs have taken effect. These factors continue to threaten U.S. and global growth, prompting the Fed to note that “uncertainties about the economic outlook have increased.” The Fed also indicated it would act appropriately to “sustain the expansion.”

Q. What other factors are contributing to the Fed’s current outlook?

CT: Although the Fed noted that economic uncertainties have increased, it left its 2019 growth forecast unchanged at 2.1%. For 2020, policymakers expect growth to slow to 2.0%. The Fed’s long-term growth expectations remained unchanged at 1.9%. The Fed also expects little change in the unemployment rate this year and next, with the rate remaining within the central bank’s estimates of long-run unemployment, which range from 3.6% to 4.5%. The Fed expects core inflation, which excludes food and energy prices and influences monetary policy, to remain slightly below its target level of 2.0% in 2019 and 2020, giving the Fed some leeway if it opts to cut rates.

Q: If the Fed is concerned about growth, why didn’t it cut rates this month?

CT: Although the U.S. economy is slowing, it remains in relatively good shape, and it’s still expanding at a faster pace than its peers. While a rate cut may refuel U.S. economic growth, the Fed believes it can hold off a bit longer, primarily to see what happens with respect to U.S.-China trade negotiations. With its latest post-policy-meeting statement, the Fed has made it clear it will act to support growth if necessary but will do so on its own timetable.

Q. How would a rate cut affect your economic growth outlook?

CT: A dovish Fed and lower interest rates likely would keep the U.S. economy growing at a relatively healthy pace. However, escalating trade tensions continue to present the greatest downside risk to U.S. economic growth and, more broadly, global growth. Taking these factors into consideration, we expect the U.S. economy to moderate from its first-quarter annualized pace of 3.1% toward trend levels of 2.0% to 2.5%. In the near term, we also believe inflation likely will stay well below the Fed’s 2% target and interest rates will remain relatively low.

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