A change in policy draws two dissents

The FED acted as we expected today.  It lowered the Fed funds rate target range to 2-2.25% from its previous 2.25-2.5%.  This was the first cut since the middle of the Great Recession in 2008-09.  It also announced (perhaps a bit less expected) that it would end quantitative tightening two months earlier than it had previously said, moving the end date to August from October 2019.

(It’s worth noting that the end of QT is considered by some another round of easing, on top of the 25 basis point cut.  However, I believe the evidence on both QE and QT are weak in causing changes in interest rates, so if there is an effect here it will be on market sentiment.  I have nothing further to add about that change at this point.)

It is noteworthy that two FOMC members dissented, preferring to wait for more data before moving towards tightening.  Esther George of the Kansas City Fed had already indicated that the deviations in inflation from its 2% target were OK with her if they were in a range +/- 0.5%.  (There was an Italian report that she was more comfortable with a rate cut this week but it appears the report was mistaken.)  President George is considered the anchor on the hawkish end of the FOMC policy spectrum and her dissent should not come as a surprise.

The other dissent — which on reflection should not have been a surprise — was Eric Rosengren of the Boston Fed.  In a recent speech he emphasized central bank independence (a topic near and dear to my heart.)  The speech emphasized the need for the Fed not to succumb to partisan pressures.  Thus I am willing to argue Rosengren tipped his hand that he was not to be forced by Washington to lower rates.

But Washington probably had little to do with it.  In a world with more and more bonds yielding negative returns (you are paying government to hold your money), the U.S. rate was drawing in huge amounts of liquidity from abroad and pushing the dollar higher.  This effect was called out by the FOMC statement in changing its statement from June to mention “the implications of global developments for the economic outlook” while saying inflation was still muted — it is as if the latter gives them permission to look at the former.  Greg Ip at the Wall Street Journal called this correctly earlier today:

The outside world has always influenced the Fed, because a foreign recession or crisis can hit U.S. exports and financial markets. Fed Chairman Jerome Powell has cited weak global growth as a reason the Fed will probably reduce rates. The new wrinkle is that the central bank is factoring not just foreign economic developments but also foreign interest rates into where U.S. rates ought to be.

“U.S. rates can diverge to some extent from global rates but there’s a limit to how far that process can go, because of integrated capital markets,” Fed Vice Chairman Richard Clarida said recently on Fox Business Network.

We are accustomed to looking at yield curves in the US, but increasing attention will need to be paid to the implications of exchange rate movements as we move into 2020.  This being a relatively uncharted part of U.S. monetary policy, we can expect more statements from FOMC members in the next few weeks as they explain the relevance of exchange rates in their decisions.  Clearly, at least two members of the committee were not convinced.


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