Powell, Eyeing Trade War, Suggests Fed Could Turn to Interest Rates if Needed - The New York Times

CHICAGO — Federal Reserve Chairman Jerome H. Powell, eyeing the potential for President Trump’s trade war to inflict damage on the United States economy, said that the central bank is prepared to act to sustain the economic expansion if needed.

“We do not know how or when these issues will be resolved,” Mr. Powell said of ongoing trade disputes between the United States, Mexico, China and other nations. “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 labor market and inflation near our symmetric 2 percent objective.”

Mr. Powell did not explicitly say that the Fed will cut interest rates but his comments send a signal that the central bank is watching Mr. Trump’s trade wars warily, ready to fend off any economic damage.

“He’s making a point to say to the markets that, ‘We can act if necessary,’” said John Briggs, a bond market strategist at NatWest Markets in Stamford, Conn. “I think the markets are taking some comfort, at least, by the idea that he’s moving in the right direction.”

While the Fed has been closely monitoring Mr. Trump’s trade dispute with China, Europe and other governments, Mr. Powell’s comments were his first since the president said that he would escalate his dispute by imposing tariffs on all Mexican goods.

Mr. Trump, speaking in London on Tuesday, said he was ready to punish Mexico with tariffs next week for failing to curb the flow of migrants across the Southern border.

“I think it’s more likely that the tariffs go on, and we’ll probably be talking during the time that the tariffs are on, and they’re going to be paid,” Mr. Trump said.

The decision to impose tariffs of up to 25 percent on Mexico — combined with growing concern over a prolonged trade war with China — has sent markets tumbling. They have gyrated as investors, bond markets and Wall Street analysts grow increasingly alarmed by the potential slowdown in growth that could result from expanded tariffs. The worsening outlook for trade over the last month has been accompanied by signs of weakness in global markets. Prices of key industrial commodities such as crude oil and iron ore have slipped.

After hitting a high on April 30, the S&P 500 was down nearly 7 percent through the close of trading on Monday. Yields on safe government bonds have tumbled worldwide, in a sign that investors see a weakening outlook for inflation and economic growth. And yields on some long-term Treasury securities are now below those of short-term bills, an unusual occurrence known as an “inversion of the yield curve,” which, in the past, has heralded recession.

Against that backdrop, investors have grown increasingly expectant that the Fed will abandon its “patient” stance and move to cut interest rates in the coming months. Fed funds futures markets are now placing a probability of more than 50 percent on the Fed reducing interest rates at its meeting at the end of July. Earlier in May, the market was putting less than 20 percent odds on such a move.

Mr. Powell’s comments on Tuesday slightly buoyed investors, who have already pinned their hopes on rate cuts this year.

Yields on short-term Treasury notes declined slightly after his comments were released. And stocks, which had been up before the speech was released, climbed further. The S&P 500 was up more than 1.5 percent by midday.

Taken with his colleagues’ recent statements, Mr. Powell’s speech signals that the Fed isn’t yet ready to lock in coming rate cuts. Federal Reserve Bank of Chicago President Charles Evans said in a CNBC interview earlier Tuesday that he’s “comfortable” with where rates are at the moment. Mary Daly, head of the Federal Reserve Bank of San Francisco, also reiterated a call for patience during an interview with CNBC.

Officials are watching trade warily, however. In a speech on Monday, the president of the Federal Reserve Bank of St. Louis, James Bullard, said that a cut in interest rates “may be warranted soon” in order to stoke inflation and “provide some insurance in case of a sharper-than-expected slowdown” in growth.

“The main story from Powell for near-term policy, in my view, is that this debate about whether the next move is a hike or a cut is effectively over,” Neil Dutta, an economist at Renaissance Macro Research, wrote in a note to clients following the speech. “They are no longer holding open the possibility of a hike.”

The president’s actions on trade have left the Fed in a tough spot. Growth remains above its longer-run trend and the job market is strong, which would argue against rate cuts. Plus, trade disputes could be resolved quickly, removing a major obstacle to continued expansion. But inflation is already low, and if a global slowdown drags on the United States economy, Fed rates are still historically low — which could argue for quick, decisive action, since the central bank’s recession-fighting ammunition is limited.

Mr. Trump himself has been pushing the Fed to cut rates, even contrasting the central bank with China’s.

“China is adding great stimulus to its economy while at the same time keeping interest rates low. Our Federal Reserve has incessantly lifted interest rates, even though inflation is very low, and instituted a very big dose of quantitative tightening,” Mr. Trump said in a tweet on April 30. He said that the economy would go up like a “rocket” if the central bank cut rates.

That also raises an optical problem for the central bank, which is independent of the White House. A move to cut rates could look political, even if it arose from a change in the economic landscape. Officials have reiterated time and again that they will make policy decisions based on the economic outlook, and that politics will not influence them in either direction.

After the Fed raised rates nine times since 2015, investors late last year began to grow concerned that monetary policy might be too tight, potentially risking the start of a recession. That helped send stock markets sharply lower, with the S&P 500 losing nearly 14 percent in the last three months of 2018.

Then, in early January, the central bank abruptly shifted its tone away from previous plans to continue lifting interest rates this year, and instead emphasized that it would remain patient, flexible and attuned to signals being sent by financial markets.

Some analysts question whether fresh Fed cuts would stimulate a similar reaction now. A decade into an economic expansion, lower interest rates might not measurably improve the outlook for corporate profits, the economy or the stock market, they say.

“This is just the reality of it,” said Michael Wilson, U.S. equity strategist for Morgan Stanley. “The Fed has done everything they can do to extend the cycle. And it might not be enough.”

Analysts have altered their forecasts for Fed policy in recent days and are now predicting as many as three rate cuts as concerns grow that the central bank will need to take drastic action to prop up the economy. JPMorgan and Evercore ISI now project a total of two interest-rate cuts starting in September, and Barclays predicts three cuts. That is up from previous estimates for either no cuts or a single rate cut for 2019.

Mr. Powell also focused on longer-run challenges facing the rate-setting Federal Open Market Committee, saying that rates near zero have “become the pre-eminent monetary policy challenge of our time.”

Against that backdrop, the Fed is concerned that inflation has been coming in below its objective for low and stable 2 percent price gains. The shortfall leaves it with even less room to cut interest rates, which include inflation, in a downturn.

“My F.O.M.C. colleagues and I must — and do — take seriously the risk that inflation shortfalls that persist even in a robust economy could precipitate a difficult-to-arrest downward drift in inflation expectations,” Mr. Powell said. He said that looking for ways to change the Fed’s policy strategy to strengthen its inflation-targeting credibility is “at the heart of the review.”

The central bank is also reviewing its approach to communication and its tool kit for combating economic downturns, and is expected to reach and report conclusions sometime in early 2020.

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