Should the Federal Reserve cut rates aggressively?

  • Economy
  • Monday, 16 Sep 2019

“The danger of pushing rates too low or even going negative, when the US economy is not in dire straits yet may leave the Fed with less ammunition when recession really hits and deepens, ” said Socio Economic Research Center executive director Lee Heng Guie.

With the cutting of interest rates worldwide, should the US Federal Reserve do so more aggressively as sought by President Donald Trump?

Within rapid intervals with different reasons cited, Trump had initially asked the Fed to cut the Fed funds rate, currently at 2.25%, by one percentage point or 100 basis points over a fairly short period of time.

After three weeks, he is demanding that the Fed lower rates to zero or negative.

Against signs of weakening in the economy and fears of recession, Trump had wanted the dollar to be weaker as the strong dollar is hurting other countries, and rates that are more competitive.

US rates that are lowered to zero or less, he said, would reduce borrowing costs, and help the government lower the cost of debt servicing ‘way down.’

The European Central Bank cut its deposit rate to minus 0.5% from minus 0.4%, and will restart its bond buying of 20 billion euros a month from November.

So far, negative rates in Europe and Japan have not worked.Trump’s rapid change in demands for rate cuts indicates the fast changing situation. From a pace of high growth supercharged by massive tax cuts, the US economy is rapidly cooling with recession being felt in the corners of the country.

Already, there is talk of a scenario similar to that in 2016, when the US economy recorded sluggish growth of 1.6%, the worst in five years, and lackluster business investment.Pennsylvania lost 8,300 jobs in the first six months of this year; the swing state of Wisconsin has lost more than 4,000 positions, according to the US Bureau of Labour Statistics.In its considerations, the Fed should not bow to pressure to cut rates that would provide room for prolonging the US-China trade war.

This is because any positive effect from rate cuts may be offset by trade policy mistakes.The longer that this trade fight and other spats involving tariffs and export/import controls are dragged on, the worse it will be for the global economy.

“The danger of pushing rates too low or even going negative, when the US economy is not in dire straits yet may leave the Fed with less ammunition when recession really hits and deepens, ” said Socio Economic Research Center executive director Lee Heng Guie.

Nevertheless, the Fed still needs to “buy insurance” in the form of rate cuts, against downside risks to US growth, caused by current trade policies.

“But that is not to underwrite bad trade policy, ’’ said Maybank Investment Bank group chief economist Suhaimi Illias.

The median probability of a US recession in the next two years is at 45%, the chance of one in the next 12 months, at 30%, said Reuters.

Bond king Jeff Gundlach sees a 75% chance of a recession before the next presidential election in 2020, citing a possible crisis in the US corporate bond market.

With investors searching for higher yields, this market has surged in size and leverage, but with weak protection.

A third of investment grade (rated BBB or higher) debt risks being rated as high yield (that offer higher rates of return due to higher risks of default).Worrying signs are emerging in the falls in manufacturing indexes; the Institute of Supply Management’s manufacturing index for August slid to 49.1, the first time in three years, and at below 50, shows a contraction

For the time being, strong retail sales indicates that US consumers are still holding up and supporting a moderate pace of growth.US jobs growth has slowed even as jobless claims fell, indicating that currently, the labour market is still strong.

A Harvard CAPS/Harris poll of 2,531 registered voters at the end of August revealed that 57% would blame Trump more than the Fed or anyone else, if the US economy enters into a recession by year end.

A JP Morgan survey showed that 65% of Americans would blame trade policies of the Trump administration for a recession in the next 12 months, and 56% would blame Trump himself.Over the next two to three months, it will be clearer if there will be a soft landing or an onrush towards US recession.

“A forward looking policy seems to be leaning towards aggressive rate cuts, ’’ said Pong Teng Siew, the head of research of Inter-Pacific Securities.Despite the urgent calls to lower rates, the Fed appears to have no current appetite for aggressive rate cuts, as it waits for further data.

Fed chairman Jerome Powell also seems quite wary of blowing asset bubbles, unlike some previous chairs.

But as time goes by, the calls for lower rates may get shriller.

Columnist Yap Leng Kuen notes some attempts at a trade war compromise amidst overall caution.

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