If the Federal Reserve fulfills expectations and cuts interest rates Wednesday, it will have to convince the public it is doing so to preserve economic growth and not kowtowing to a very vocal president who is demanding looser monetary policy.
The Federal Open Market Committee and Chairman Jerome Powell have a delicate balance to strike if they approve what markets are betting is a 25 basis point easing.
If the committee presents a reasoned approach to why a cut is necessary just seven months after hiking, it has the potential to execute the move seamlessly.But if the perception emerges that policymakers are merely looking to mollify President Donald Trump, then the central bank’s credibility, and its veil of political independence, could be torn asunder, resulting in damage that could take years to fix.
After all, the economic signs in the U.S. look good. GDP rose a better-than-expected 2.1% in the second quarter, unemployment is around a 50-year low and consumer metrics, which already had been looking good, are only getting stronger.
Cutting rates has rarely if ever been done in such an environment. Explaining that an easing now is anything but a political move in the face of all of Trump’s demands won’t be easy — even if Powell and Co. think Trump is right.
“How do you window-dress that? How do you explain your actions other than to say the president’s right?” said Fed veteran Christopher Whalen, head of Whalen Global Advisors. “That’s tough for that institution to do that.”
Whalen thinks Powell should stick to the position he set forth last year, which was to adopt a patient stance, allowing a sizable chunk of the bonds the Fed is holding on its balance sheet to run off before moving on rates.
The Fed has drained about $650 billion in a reduction program that started in 2017, but the portfolio of Treasurys and mortgage-backed securities remains at a lofty $3.6 trillion. Many economists expect the FOMC to announce, along with the rate cut, a cessation of the balance sheet runoff, even though it was supposed to end in September anyway.
“You’ve got a relatively weak chairman who is getting beaten up by a very volatile president,” Whalen said. “For the sake of the Fed and their credibility long term, not just now but long term after Trump is gone, they want to take their time.”