Fed Readies First Interest-Rate Cut Since 2008 - The Wall Street Journal

How Federal Reserve Chairman Jerome Powell frames the economic outlook will shape the market reaction... — How Federal Reserve Chairman Jerome Powell frames the economic outlook will shape the market reaction to the central bank’s Wednesday decision. Photo: Susan Walsh/Associated Press

Nick Timiraos

The Wall Street Journal

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July 31, 2019 5:00 am ET

The Federal Reserve is expected to say Wednesday it will reduce its benchmark interest rate by one quarter percentage point. That would mark just the fifth time in the past 25 years that the central bank switched from raising to lowering rates.

In the four prior cases, the Fed never cut rates just once. In 1995 and 1998, officials made three small reductions over a few months, and the economy avoided a downturn. In 2001 and 2007, they began deep and sustained cuts to stimulate an economy entering recession. The most recent Fed rate cut occurred in late 2008, when the central bank lowered rates to near zero after the financial crisis and then held rates at that level for seven years.

Fed officials have approvingly cited the examples of the 1990s, which could reflect hopes that a few small cuts now will keep the decadelong expansion going and avoid a full-blown rate-cutting cycle.

The Fed’s new policy statement, to be released at 2 p.m. EDT, and a press conference by Chairman Jerome Powell at 2:30 p.m. should provide more clarity. No new economic or interest-rate projections are scheduled for release. Here’s what to watch:

The Rate Decision

The coalition of officials favoring a quarter-point rate cut at this week’s meeting have cited four reasons for cutting now, when the economy looks OK.

First, they are worried weaker global growth and trade uncertainty are chilling business investment, which could ultimately weaken hiring and consumer spending, the engine of the U.S. economy.

Second, officials are troubled that inflation softened earlier this year, when they expected it to reach their 2% target.

Third, stock- and bond-market conditions have been buoyant recently because investors expect the Fed to lower rates. Failing to cut would, in effect, serve to tighten policy, which could further weaken investment.

Finally, officials have said that because interest rates are already historically low, leaving less room to cut if needed to combat a downturn, they want to act pre-emptively. One recent lesson inferred by Fed policy makers from the experiences of other countries with low rates is that “you don’t need to wait until things get so bad to have a dramatic series of cuts,” said Fed Vice Chairman Richard Clarida in a Fox Business Network interview two weeks ago.

While this led some analysts to speculate the Fed might reduce rates by a half-percentage point, such a cut “would be very difficult to explain in the context” of recent good economic data, said Lou Crandall, chief economist at financial-research firm Wrightson ICAP.

Watch the policy statement for how the Fed explains its reasons for acting as it does.

The Rate Path

Because a rate cut is already expected, how Mr. Powell frames the economic outlook and the policy debate will shape the market reaction to Wednesday’s decision.

Specifically, watch to see if he opens the door to another rate cut. In June, seven of 17 officials projected interest rates would fall by a half-percentage point by year’s end, a clear sign that several officials, including Mr. Powell, may not view this rate cut as “one and done.”

Also watch the rationale he emphasizes for this rate move. If declining inflation and public expectations of future inflation are prompting the rate cut, officials could see more reason to lower rates again this year. One quarter-point cut isn’t likely to do enough to boost price pressures.

The Portfolio

The key question at the Fed meeting will be how to communicate current thinking around the policy path. One component of this is whether to end the runoff of the Fed’s $3.8 trillion asset portfolio two months ahead of the schedule.

Some Fed officials have said they don’t see any reason to change the process because it is already set to end in September. But Mr. Powell hinted in June they might stop it early to avoid sending conflicting signals with different tools—by easing policy with lower rates while tightening policy with the runoff.

At times, markets have interpreted decisions about the portfolio as a signal of future intentions on rates. One argument for ending the runoff early is that would provide a more market-friendly message without giving up more ammunition in the form of additional rate cuts.

It is a close call, and either way, markets may watch this decision as another sign of the possible rate path.

Dissents

Mr. Powell faced his first dissent on a policy decision last month, when St. Louis Fed President James Bullard voted against holding rates steady because he preferred a cut. Because of the Fed’s rotation system, just five of the 12 regional Fed bank presidents have a vote on policy, though the others participate fully in the policy debates.

Recent remarks from Kansas City Fed President Esther George and Boston Fed President Eric Rosengren, also voters this year, raised questions among Fed analysts about whether either might dissent against a cut because they would prefer leaving rates unchanged.