The Week: The Fed has bitten the bullet on interest rates

The Federal Reserve has bitten the bullet on interest rates, but will the 25bps rise make any difference to the global economy?

  • Jerome Powell said that weakness in the global economy and trade tensions had prompted the cut
  • The cut is designed to address the long-term strength of the Dollar, which has weighed on global growth
  • However, the Fed may not have gone far enough

The Federal Reserve cut interest rates as expected this week. Federal Reserve chair Jerome Powell said that weakness in the global economy and trade tensions had prompted it to lower the target range for federal funds to 2-2.25%. With US GDP growth coming in stronger than expected, at 2.1% for the second quarter, does the move seem premature?

Why does the US suddenly care about the rest of the world? Part of the problem has been the strength of the Dollar. US outperformance, fiscal stimulus and higher interest rates has pushed the US currency higher. This has proved a strain for those countries with Dollar-denominated debt. This has dented growth at the same time as trade tensions between the US and China have hurt manufacturing. 

However much Trump would prefer it otherwise, the world economy is still essentially ‘global’. That means the US economy can’t avoid these problems. While its GDP growth has been resilient, this has largely come from a strong consumer. Business investment and manufacturing have struggled. 

As New York Fed President Williams said “when you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress.” Nick Wall, co-manager of the Merian Strategic Absolute Return Bond Fund, said the Fed could have gone further: “The Fed’s decision to cut 25 basis points, while signalling a willingness for deeper cuts, is a positive step but could be a missed opportunity. We believe they should have gone further and cut 50 basis points today in order to weaken the dollar, raise inflation expectations and steepen the Treasury curve.

He argues that by only cutting in small steps the Fed risks further dollar strength. Certainly, early signs suggested this to be the case. In the wake of the cut, the S&P 500 of US stocks dropped and the dollar rose. Powell described it as a “mid-cycle adjustment to policy” and that wasn’t enough to convince markets of his strength of feeling. 

Nevertheless, for central banks around the world, particularly those in emerging markets, it is a welcome reprieve, allowing them to cut their own interest rates. Even if the Dollar has risen in the short-term, it should signal the end of a structurally higher US currency. It’s not much, but it should help shore up global economic growth….for now.

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