Home / Business / Make no mistake, the Fed will pay a premium when it cuts rates this month

Make no mistake, the Fed will pay a premium when it cuts rates this month



"If you drive in fog, ice or snow, the most important rule is to keep your distance. This is the number one rule, two, three … and up to ten. "

This has even been said by the kind person who takes us to Zurich Airport today. He was referring to wintertime driving here. For me, it sums up perfectly the dilemmas that the Federal Reserve faces, because it decides the amount of the interest reductions at the end of the month (yes, it's not about whether they will reduce but by how much) .

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "While the US economy is facing "cross currents" it remains in a "good situation" (using two of President Powell's preferred descriptors), that is to say that the national economic dynamic can, at least for the moment, overcome the obstacles related slowing growth in the rest of the world, trade policy uncertainties and growing monetary tensions, judging by & nbsp;Remarks by Fed Chairman Powell to Congress last week, data-reactid = "17"> While the US economy is facing "cross currents", the world's most powerful central bank is on the verge of lowering its rates. remains "in the right place" (using two of President Powell's preferred descriptors) – that is, the national economic momentum can, at least for the moment, overcome the barriers of slowing growth in the rest of the world, uncertainties about trade policies and rising costs. However, judging by Fed Chairman Powell's remarks to Congress last week, the world's most powerful central bank is on the cusp of lowering rates, opening the door for banks elsewhere to soften their monetary policies.

US Federal Reserve Chairman Jerome Powell said on Wednesday that cross-currents such as trade tensions and global growth concerns weighed on US economic activity and prospects. (Photo of Liu Jie / Xinhua via Getty)

It is difficult to justify a rate reduction with traditional measures. The unemployment rate has reached its lowest level in five years, inflation is not much below target, financial conditions are the most volatile for almost two decades, stock market indices have interest rates are already low. Yet, the Fed is under enormous pressure on the market and the political pressure to reduce its spending. And it will do so by invoking the concept of "insurance reduction", that is, to increase monetary stimulus now to reduce the risk of future damage.

But like most assurances that you and I get, the one the Fed is going to subscribe to is not free for four main reasons:

  • The more the central bank has today, the less leeway it will have later if the country's economic momentum weakens. (Do not forget that the current economic expansion in the United States is already unusually long and that it has also set a new record minus a month.)

  • The stronger the policy of easing, the more the signal sent to investors and traders to boost their risk appetite is even stronger – and this at a time when several indicators of excessive risk-taking are flashing already in yellow, even in red.

  • As easing measures are not expected to have significant beneficial economic effects, business and economic fundamentals will be even lower than already high asset prices, thus accentuating the threats of economic growth. 39, future financial instability that could cause economic harm.

  • The more the Fed stimulates when the economy is in a good position, the more it will be seen as an assignment to undue pressure from the markets and the White House. This could undermine its credibility and the effectiveness of its future directions.

The Fed will balance this out at the policy meeting of its Federal Open Market Committee (FOMC) on July 30-31. And with the option of not dropping rates virtually at home (as this would likely trigger considerable market volatility and a very political political reaction), the question arises as to whether it is necessary to reduce interest rates by 25 or 50 basis points.

The most likely outcome – and this is a high probability – is a 25 basis point cut, articulated in language that suggests the possibility of further cuts later this year, reducing the risk of negative market reaction and policy.

But, make no mistake, the Fed will pay a premium for this insurance reduction; and it is a bonus that could be important if the economy is struggling because of internal or external disruption.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Mohamed A. El-Erian is the chief economic advisor of Allianz, parent company of PIMCO, where he served as CEO and co-director of information (2007-2014). Bloomberg columnist and editor of the Financial Times, he chaired the Global Development Council of President Obama and is the author of two best sellers of the New York Times: the 2008 "When markets collide"And 2016"The only game in town. ""data-reactid =" 40 ">Mohamed A. El-Erian is the chief economic advisor of Allianz, parent company of PIMCO, where he served as CEO and co-director of information (2007-2014). Bloomberg columnist and editor of the Financial Times, he chaired the Global Development Council of President Obama and is the author of two best sellers of the New York Times: the 2008 "When markets collide"And 2016"The only game in town. "

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