The Federal Reserves top policy makers are not yet ready to cut interest rates, but worsening trade tensions are nudging them in that direction.
On Tuesday, Fed Chair Jerome Powell reassured nervous investors the Fed is watching closely for signs that disputes between the U.S. and its trading partners are denting the outlook for the world’s largest economy. The remarks moved the Fed slightly closer to its first rate cut since 2008.
Powell may have opened the door a crack wider to the possibility that the Federal Reserve will ratify one or two of the rate cuts the markets have discounted this year, said Chris Rupkey, chief financial economist at MUFG Union Bank NA.
Other Fed watchers said Powell fell short of signalling a move at the June 18-19 gathering of the Federal Open Market Committee. .
Nonetheless, the acknowledgment of risks posed by the deepening trade spats lent comfort to investors, who have aggressively increased bets the central bank will ease this year. The S&P 500 Index of U.S. stocks jumped 2.1% on Tuesday, the most since January, while the yield on 10-year U.S. Treasuries rose from Mondays 20-month low.
Buying Time
Powell is essentially telling the markets that the Fed is alert to what is happening, said Roberto Perli, a partner at Cornerstone Macro LLC in Washington and former Fed economist. But at the same time it is too soon to judge the impact on the U.S. outlook because, as he says, nobody can know how the situation will evolve. So he seems to be buying time.
Chicago Fed President Charles Evans, who votes on policy this year, said on Wednesday that he still sees the economy’s fundamentals as solid, but was concerned about continued weak inflation.
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Its early to make a judgment on that, Dallas Fed chief Robert Kaplan said: “We’re going to be very vigilant in understanding these heightened trade tensions. See if they feed through to the economy. Most importantly, see if they persist.”
Financial markets took their latest turn after President Donald Trump threatened last week to slap new tariffs on Mexico unless it stemmed migrant flows to the U.S. That comes atop deteriorating negotiations between the U.S. and China over a lengthy list of trade and commercial disputes that have led to raft of new levies in both directions.
Speaking at Fed conference in Chicago Tuesday, Powell referred to trade negotiations and other matters, before saying, 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.
Data Points
Officials will get two important new data points this week. A gauge of U.S. service industries, the ISM non-manufacturing index for May, is due out on Wednesday, while the Labour Department is scheduled to release its May jobs report Friday.
The Fed is being just as patient about lowering rates as it was about raising rates, said Mark Vitner, a senior economist at Wells Fargo & Co. in Charlotte, North Carolina. While the markets have reacted so viscerally to the ratcheting up in the trade rhetoric, the Fed needs some time to see how it will play out.
The prospect of lowering rates will likely to cause some unease at the Fed. That is because with the target range for their benchmark rate currently at 2.25% to 2.5%, officials are already wringing their hands over how little room they have to slash borrowing costs in the event of a recession before hitting zero.