Fed in three voices: recession, bubbles, and ‘in a good place’

Reuters | Published: 00:00, Sep 22,2019


After delivering a split-decision rate cut earlier this week, US Federal Reserve officials put their divisions on full display Friday, with warnings of a slowdown on the one hand and financial risks on the other bookending talk of how well things are going.

Central bankers are often called on to speak with one voice, but the Fed now has three - those ready to reduce rates even lower to ward off economic risks, those who prefer to stand pat and watch the data for now, and those warning that the Fed may already be fuelling a credit bubble.

‘The economy is in a good place,’ Fed vice-chair Richard Clarida said in a CNBC interview, noting that while there are risks, there is also a ‘virtuous circle’ under way of job gains, wage gains, and increased spending among households.

Consumption accounts for nearly 70 per cent of the US economy, and ‘I cannot think of a time in aggregate when the consumer has been in better shape,’ Clarida said.

Fed policymakers voted 7-3 to reduce their target overnight policy rate by a quarter of a percentage point on Wednesday, to a level of between 1.75 per cent and 2.0 per cent. It was the second Fed rate reduction this year.

The move, which Clarida supported, was aimed at offsetting slowing global growth and risks associated with US president Donald Trump’s trade battles with China.

But, as the first Fed decision since 2016 to draw three dissents, it’s clear there was a split. A range of views at the US central bank is not unusual with 17 policymakers around the table, 10 of whom get to vote on rates at any given meeting.

What’s unusual now is the crisp division and the reasons driving it, all against the political context of a president who wants deep rate cuts for a wholly different rationale.

Trump, facing reelection next year, has lashed out at Fed policymakers with an array of sometimes personal insults, most recently calling them ‘boneheads’ and suggesting chair Jerome Powell was an enemy of the state for not heeding his demands.

For Trump, who argues the US economy is the strongest ever, the logic is simple: cut rates to make it even stronger, with little or no risk because inflation is so low.

But even those who agree with lower rates see the situation differently, with St Louis Fed president James Bullard arguing that the Fed should have cut deeper this week to ward off weakness that includes a manufacturing sector which ‘already appears to be in recession.’

At the other end of the spectrum was Boston Federal Reserve President Eric Rosengren. ‘Additional monetary stimulus is not needed for an economy where labour markets are already tight,’ Rosengren wrote in a note explaining his own dissent from the Fed’s rate cut.

In a challenge to Trump’s view that low rates are costless to the economy, Rosengren said current Fed policy is now actively nudging people to borrow and ‘risks further inflating the prices of risky assets and encouraging households and firms to take on too much leverage.’

Not so, Dallas Fed president Robert Kaplan told reporters after an event in Corpus Christi, Texas. Cutting rates in July and September, he said, ‘will improve the growth outlook and it may make it in fact less likely that there are incentives for people to borrow and leverage and take risk – they may still do it, but it won’t be because rates are lower.’

Kaplan, who didn’t vote on the rate cut but argued in favour of it, said he has pencilled in no further rate cuts this year, and just one next year.

This week’s rate cut followed an even larger shift in the Fed’s policy outlook since late last year, when many officials expected they would still be raising rates through 2019.

Global growth and global bond markets started pushing in the other direction, however, opening a wide gap last spring and summer between the Fed’s policy projections and what investors anticipated would happen.

As a result of the change in rates and updated economic views, that gap has narrowed substantially, a positive development for a central bank whose top officials are being careful now not to flag what their next move might be until there is more information about the economy’s underlying health and direction.

After a spate of negative news over the summer, recent data has included positive surprises, including stronger-than-expected home sales, stock markets approaching new records, and a restart of US-China trade talks - a counter to Bullard’s more dire view.


Officials’ projections issued last week show the 17 Fed members split into roughly equal groups, with seven projecting one more rate reduction this year, five seeing no change, and five expecting that a rate hike will be appropriate by the end of the year.

The projections are issued anonymously, and while on Friday Kaplan revealed his views, it remains unclear where other influential officials, and most importantly Powell and Clarida, fit in that mix.

In his remarks Clarida hewed close to the language Powell used in a Wednesday press conference, saying the Fed would ‘act as appropriate,’ and watch incoming economic data for decisions that will be made ‘meeting by meeting.’

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