By Albert Lu
President Trump wants the Federal Reserve to lower interest rates further. But Federal Reserve Chairman Jerome Powell sees little reason to do so.
In his message to Congress on Wednesday, Powell insisted that politics play “absolutely no role” in the committee’s decisions, adding that favorable economic conditions make further rate cuts unnecessary in the near term. In response to Trump’s call for negative interest rates, similar to those in Japan and Europe, the chairman explained his view that negative interest rates “would certainly not be appropriate in the current environment.”
Indeed, there are reasons for optimism. The U.S. economy added 128,000 jobs in October and both unemployment and consumer inflation appear to be holding at healthy levels. Furthermore, both the Dow and S&P 500 closed at record highs on Wednesday. All this despite a synchronous slowdown of the global economy and uncertainty over U.S.-China trade relations.
NOT EVERYONE IS CONVINCED
According to Danielle DiMartino Booth, CEO of Quill Intelligence, an abundance of evidence, including a slowing U.S. auto sector, points to a slowing economy. More importantly, concerns over bank liquidity appear to have the Fed backed into a corner.
“The Fed is back-pedaling … and we’re blowing up the balance sheet,” she said in reference to the Fed’s temporary operations in the overnight lending market.
The bond purchase operations, which some have criticized, came in response to a liquidity crunch in September that briefly pushed the overnight lending rate from 2% to 10%. The Sept. 17 incident was the first time the Fed interfered in the overnight market since the financial crisis. Banks short on cash typically access the repurchase agreement (or ‘repo’) market to cover their obligations each night. Spiking overnight rates can indicate stress in the banking system.
The Fed’s repo operations and subsequent T-bill purchases have prompted comparisons to the notorious quantitative easing program which, over three rounds spanning roughly six years, saw the Fed increase its balance sheet by $4.5 trillion. While the programs are not identical, particularly in the duration of the targeted assets, the similarities are hard to ignore.
“It’s pretty apparent that the Federal Reserve is going to continue to grow its balance sheet … It’s at a $1.5-$1.6 trillion annualized run-rate and I don’t see Jay Powell stopping any time soon,” said DiMartino Booth when asked about the Fed’s next move.
“I think he’s going to crank up the money printing as much as he needs to, to try to forestall any type of credit event that seeps its way into the financial markets, because then it’s game-over for the U.S. economy.”
“There’s also a matter of optics now. They want to have it appear as if it is a Greenspan-esque 1995 or 1998 event, where you could do three interest rate cuts and have the economy continue to expand, have the markets continue to rally.”
“But we’re supposed to just disregard the massive amount of ‘not-quantitative easing,’ because he won’t call it ‘quantitative easing,’ that’s going on in the background in order to prop this up.”
QE OR NOT-QE
Regardless of the name, the Fed’s latest move to bolster reserves and restore liquidity is a sign of possible trouble ahead. In his statement to Congress, Powell admitted that, with interest rates already so low, he may lack the necessary tools to fight the next recession. In his prepared statement to Congress, the chairman enlisted the help of the federal government by suggesting that additional stimulus, through government spending, would be necessary to fight a recession.
But as the federal deficit grows to $1 trillion in 2020 how realistic is this?
In DiMartino Booth’s assessment, the burden will fall squarely on Powell.
“There might have been speculation about how willing Jay Powell was to crank up the money printing machine. Banks have got his number now … he’s going to print as much as he needs to.”