Concerns about trade policy and a weak global economy “continue to weigh on the United States economic outlook” and the Federal Reserve stands ready to “act as appropriate” to sustain a decade-long expansion, said the Fed’s chairman, Jerome Powell.
Prepared remarks by the head of the US central bank – delivered to a committee of the US Congress on Wednesday morning – may bolster expectations of an interest rate cut later in July.
Powell contrasted the Fed’s “baseline outlook” of continued US growth against a set of significant risks: persistently weak inflation, slower growth in other major economies, and a downturn in business investment driven by uncertainty over the duration and intensity of trade wars waged by the administration of US President Donald Trump – especially Trump’s year-long trade war with China.
At their June policy meeting, Fed officials had signaled those concerns might warrant lower rates, and “since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US outlook”, Powell said.
“Apparent progress on trade turned to greater uncertainty, and our contacts in business and agriculture reported heightened concerns over trade developments,” Powell said, noting that business investment, an important component of economic growth, “seems to have slowed notably” in the last few months.
The Fed chair said overall growth has also “moderated”, and cited the possibility that “weak inflation will be even more persistent than we currently anticipate”.
“Powell is setting it up, certainly for a July rate cut,” Jack Ablin, chief investment officer at Cresset Capital Management in Chicago, told the Reuters news agency. “To me, it all depends on where you look in the economy. But over the last decade, the Federal Reserve has been banging the inflation beehive with a baseball bat and the bees haven’t come out. So they figure keep trying this until something happens.”
US stock index futures gained early on Wednesday, turning positive after Powell’s remarks were released, while the US dollar fell against a basket of other currencies.
Government bond yields dipped, with two-year US Treasuries falling below 1.87 percent, from around 1.93 percent. Meanwhile, interest rate futures appeared to price in greater odds of an aggressive rate cut of half a percentage point in July.
Powell presented his remarks and then took questions from members of the US House of Representatives Committee on Financial Services. He will testify again on Thursday before the US Senate Banking Committee.
His appearances come at a particularly sensitive time for the Fed – and for Powell personally, with Trump lashing out at his own handpicked Fed chief for not yet cutting interest rates that, in Trump’s view, are needlessly slowing the economy.
At the same time, in the view of Fed officials, Trump’s policies – including higher tariffs and an unpredictable governing style – have increased economic risks and led them to consider the same rate reductions Trump has demanded.
The Fed has kept its current benchmark overnight interest rate in a range of between 2.25 percent and 2.50 percent since December.
Since a series of Trump trade tweets in late May, both investors and the Fed have begun shifting their stance, with markets now expecting a cut of at least a quarter of a percentage point when Fed policymakers meet at the end of the month.
US economic fundamentals may not have changed much in the days that followed Trump’s May 30 comments on Twitter threatening to impose tariffs on Mexico unless the country met his demands for tougher controls on immigrants crossing the US-Mexico border.
But Trump’s statements spooked financial markets so decisively, and the threats to the global economy became so palpable, that a rate cut now appears almost certain.
“The Fed has never disappointed a market with such strong expectations of action,” Joseph Lavorgna, chief economist for the Americas at Natixis, wrote in a recent analysis.
With investors in contracts linked to the Fed’s targeted overnight lending rate putting the probability of a rate reduction at close to 100 percent, “it would be unprecedented for the Fed to not cut”, Lavorgna wrote.
Following the hearing on Wednesday, the Fed is to release the minutes from its last policy meeting, which should show the extent to which the thinking at the central bank shifted in the days following Trump’s Mexico tariff threat, and how the discussion was shaped by other concerns including weak inflation.
Though US economic growth remains largely on track, and the jobs report for June showed continued strong hiring, the events of May changed US trade policy from something of a sideshow in the Fed’s view to a central concern.
Earlier rounds of US tariffs on trading partners – including China – had been dismissed as of little macroeconomic importance, with the Fed in early May still anticipating its policy rate would remain unchanged for the rest of the year.
By contrast, the higher tariffs announced against China in early May, a fear that the world’s two largest economies might not be able to make a deal, and the tariff threat against Mexico, all added to the growing feeling that protectionism and higher tariffs were here to stay – at significant cost to investment and growth.
Though the case for lowering borrowing costs isn’t fully decided, reducing rates at this point would be similar to the Fed’s efforts in the mid-1990s to nurse along a lengthy recovery rather than respond to a looming downturn.
In the Fed’s monetary policy report issued last week ahead of Powell’s testimony, the trade war received its own analysis, a sign of the attention it is getting within the central bank.
Fed staff concluded the rise in world tariffs had a likely “material” impact on the slowdown in global trade last year, and that “uncertainty surrounding trade policy could be leading firms to delay investment decisions and reduce capital expenditures”.
Though the threatened tariffs on Mexico never materialised and China and the US have agreed to resume talks to reach a trade deal, that “did little to alleviate the uncertainty that Fed officials believe is contributing to cooling momentum in global trade and domestic capex plans”, Deutsche Bank’s US economics team wrote this week.