Inside the Fed’s Head

Amid renewed Presidential criticism and evidence of a slowing economy, Fed officials will convene a two-day policy meeting this week and the pressure is on. As always, central bankers have to balance maintaining a strong enough economy to foster job growth, but it can’t run too hot, which might trigger inflation. Right now, there’s a battle brewing inside the collective Fed’s Head between action and inaction.

The case for cutting sooner rather than later goes something like this: After a buoyant 2018 (GDP +2.9%) and Q1 2019 (GDP +3.1%), growth has slowed down. Job creation has cooled from its red hot pace in 2018, manufacturing has been steadily declining since peaking last summer, and the trade conflict with China continues to weigh on sentiment and is hurting some specific sectors. On top of those factors, inflation has persistently fallen below our target of two percent and we really don’t want the U.S. to turn into a sluggish giant, like Japan or Europe, so let’s get on top of this and cut rates NOW!

Diane Swonk, the Chief Economist of Grant Thornton, favors a June cut for all of those reasons, and adds that by moving this week, the Fed could “control the narrative on its forecast, which is expected to drop.” In other words, if the Fed economic projections reveal a bias to cut rates, but they don’t actually follow through, it “could fuel confusion instead of clarity in financial markets.”

Here’s the case for doing nothing right now and waiting until July: While all of those factors cited above are brewing, a lot could change the dynamic over the next six weeks. First of all, there will be additional data released, which could provide more answers about the labor market and other areas of the economy. Just Friday, there was evidence that consumer spending picked up in April and May, so maybe second quarter growth won’t be so terrible, after all. Additionally, the G-20 meeting in Japan at the end of June might provide an opportunity for President Trump and Chinese President Xi to bury the hatchet on the trade war, or at least get the talks restarted.

According to Mark Spindel, co-author of The Myth of Fed Independence, “the problem with waiting until the economic data deteriorates further is that it could be too late. And if the central bank’s economic projections that accompany this week’s meeting show that the economy is indeed slowing and that Fed officials predict cuts of 0.75-1.0 percent before the end of the year, why not bite the bullet and do it now?”

Whether it acts in June, July or at the September meeting, the Fed’s mindset has already shifted from tightening to loosening interest rates, that happened back in January. Investors put the odds of rate cut at 23 percent for the June meeting, 87 percent for July and 97 percent at the September meeting.

Lower interest rates might allow the current expansion, one that is about to become the longest on record in a few weeks, to continue. But at some point, there will be a recession and when it comes, the Fed will get blamed for it, regardless of when they act, you can take that prediction to the (central) bank.