The Federal Reserve has warned on the rising downside risk to the economy in the months ahead, according to the minutes of its September policy meeting at which it cut interest rates for the second time this year.
The minutes, released on Wednesday afternoon, showed the US central bank’s statistical models on the likelihood of a recession in the medium term had increased and that policymakers were generally more concerned with risks associated with the trade war and geopolitics.
In the policy statement accompanying its September rate decision, the Fed noted the improved health of the consumer, with household spending rising at a “strong pace”, but pointed out business fixed investment and exports had “weakened” since its July meeting, when it delivered the first rate cut since the financial crisis.
“Participants generally judged that downside risks to the outlook for economic activity had increased somewhat since their July meeting, particularly those stemming from trade policy uncertainty and conditions abroad,” the minutes said.
“In addition, although readings on the labour market and the overall economy continued to be strong, a clearer picture of protracted weakness in investment spending, manufacturing production, and exports had emerged.”
James Bullard, president of the St Louis Fed, broke from the ranks of other dovish policy-setting members last month by voting for a steeper rate cut of 50 basis points. Esther George of the Kansas City Fed and Eric Rosengren of the Boston Fed voted in September, as well as July, to keep the target range unchanged.
Wall Street shrugged off the release, with the S&P 500 holding on to its gains of nearly 1 per cent. US Treasuries saw a muted reaction as well, with the yield on the policy-sensitive two-year Treasury bill up 3.1 basis points to 1.47 per cent, and the yield on the benchmark 10-year note fell less than a basis point to 1.58.
Market expectations for the future path of monetary policy have gyrated wildly in recent weeks, with the implied probability of a quarter-point cut at this month’s meeting rising dramatically from the 40 per cent probability seen at the end of the month, according to futures prices compiled by Bloomberg.
Expectations barely budged following the release of the meeting, with the odds of a third cut since the financial crisis elevated at 78 per cent. Should Mr Powell move ahead with a quarter-point reduction in the Fed’s benchmark policy rate, investors are pricing in two more cuts before the end of next year.
A few FOMC participants expressed concerns about the financial markets expectations about the federal funds rate. They suggested the Fed should use its post-meeting statement “to provide more clarity about when the recalibration of the level of the policy rate in response to trade uncertainty would likely come to an end.”
Noelle Corum, a portfolio manager at Invesco, said the recent spate of economic data and growing uncertainty between the US and China over trade policy pointed to a cut at the end of the month as well as another in December. Still, the Fed is challenged not only in how it communicates these risks, but also navigates the many divisions among its own officials.
“The Fed is threading the needle between the positive growth picture in the US and the need to cut rates,” she said. “While a divided Fed makes it interesting . . . at the end of the day they can’t ignore the data”, which Ms Corum said points to a weakening consumer.
The Fed continued a discussion in September of its policy framework, or its set of tools for carrying out its goals of stable prices and full employment. The discussion shows broad concern that the Fed’s policy rate, currently at 1.75 to 2 per cent, will probably drop back to zero and “bind”, or stay there, during the next recession, forcing policymakers to turn to other tools.
Some members worried that low inflation in Europe and Japan was a risk for the United States as well. “These participants pointed to long, ongoing [zero or low policy rate] spells in other major foreign economies,” the minutes recorded, “and suggested that, to avoid similar circumstances in the United States, it was important to be aggressive when confronted with forces holding inflation below zero.”
The Fed also discussed using a “make-up” strategy, in which policymakers promise to make up for past inflation shortfalls with a commitment to higher inflation during a downturn. This strategy, Fed staff warned, required clear communication.
In debating the current economic outlook, policymakers were concerned about the proximity to zero rates. A few members of the group worried about trade uncertainty argued that easing sooner would prevent the Fed from having to leave interest rates lower for longer. But the group arguing to wait to drop the Fed’s policy rate made a parallel argument.
“A couple of participants suggested that, if it decided to provide more policy accommodation at the present juncture the committee might be taking out too much insurance against possible future shocks, leaving monetary policy with less scope to boost aggregate demand in the event that such shocks materialised.”
Additional reporting by Colby Smith and Mamta Badkar in New York