- For the first time since December 2008, the Federal Open Market Committee (FOMC) reduced its benchmark U.S. interest rate
- The move – which lowered the Federal Funds rate by 25 basis points (0.25%) to a range of 2.00%-2.25% – was widely expected by global financial markets
- The Committee also decided to end its balance sheet adjustment program two months earlier than scheduled
- Looking ahead, the Committee has left itself room to deliver additional stimulus; however, it suggested that any further easing actions may not materialize as quickly as financial markets may have anticipated
- TIAA’s Investment Management Group (IMG) expects that the economic expansion which began in 2009 will continue in the quarters ahead and that the rate cut does not signal that a recession is imminent
- The rate cut does not materially alter IMGs’ view of the equity or fixed income markets
- The 25-basis-point cut lowered the Federal Reserve’s (Fed) target interest rate to 2.00%-2.25%, right in line with IMG’s expectations.
- The Committee acknowledged that the labor market is strong and economic growth is moderate – very similar to its assessment of conditions at the June, 2019 meeting.
Why ease now?
- Fed policymakers are concerned about a recent increase in the risks confronting the U.S. economy, like subdued inflation and potentially damaging global developments.
- The central bank’s preferred measure of inflation has remained stuck below its 2% target for most of the past seven years. It now stands at 1.6%.
- The Fed also wants to prevent the public’s inflation expectations from falling further. If consumers and businesses expect prices to keep falling, they are likely to postpone purchases which would, in turn, undermine economic growth.
- Demand from U.S. trading partners overseas, especially China, has been dwindling because many of those countries are experiencing weaker economic growth.
- Business confidence in the U.S. has been dampened by rising uncertainty about the ongoing trade dispute with China, the Eurozone and other countries. As a result, many American firms have grown reticent about indulging in additional spending.
- Federal Reserve Chairman Jerome Powell recently justified relaxing monetary policy at this juncture by noting that an ounce of prevention is worth a pound of cure. The Fed hopes easing induces more spending which would stimulate the economy.
- Chairman Powell also noted recently that one of the FOMC’s objectives is to sustain the expansion because some communities are only now experiencing its benefits for the first time since it began ten years ago.
- The benefits outweigh the risks.
- Some market participants are concerned that lowering rates limits the amount of ammunition available to the Fed if it needs to fend off recession.
- Others fear that pumping more stimulus into a still-healthy economy raises the risk of inflating asset bubbles which could damage the economy if and when they burst.
- Chairman Powell noted – and IMG agrees – that there are few, if any, indications of dangerous imbalances building up in the nation’s financial system as a result of misallocated resources. Accordingly, the benefits of the 25-basis-point easing outweigh the potential risks.
- In IMG’s view, U.S. economic growth remains on a decent trajectory. Moreover, the unemployment rate is at the lowest level in 50 years, wages are accelerating modestly, and consumer confidence is still upbeat.
- Financial markets got what they expected from the Fed. However, the U.S. dollar approached two-year highs after the decision was announced. From the perspective of corporate earnings – the key driver of equity prices – a rising dollar hurts U.S. multinational companies.
- IMG does not believe a 25-basis-point easing will do much to increase business investment, and we continue to think the risk/reward in the equity market is currently less attractive than it was 12 months ago.
- In the coming weeks, Fed officials may offer more clarity around their perceptions of the outlook and possible risks. This raises the possibility of intermittent bouts of financial market volatility – especially given potentially lower market liquidity which is typical of the summer months.
- Along with a subtle change to the language used by the FOMC to discuss its approach to the outlook, Fed Chair Powell emphasized that a) this week’s easing does not necessarily represent the beginning of a lengthy series of cuts but b) this may not be the final cut either.
- In IMG’s view, the Fed Chair is keeping all options open in light of the uncertain road ahead. The U.S. economy still shows a reasonable amount of momentum, and – barring major shocks to the system – significant amounts of additional monetary stimulus may not be required. Financial markets are currently projecting at least one more interest rate cut in 2019.