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Federal Reserve expected to cut rates

By SCOTT REEVES in New York | China Daily Global | Updated: 2019-08-01 00:05

Traders work after the opening bell at the New York Stock Exchange located at Wall Street in New York City, on July 29, 2019. Wall Street stocks were mostly lower early Monday at the start of a week jammed with news, including a Federal Reserve decision. [Photo/VCG]

The US Federal Reserve, facing what it sees as a global slowdown that could damage the domestic economy, is expected to cut interest rates on Wednesday for the first time since 2008, when the collapse of the subprime-mortgage market precipitated a worldwide financial crisis.

Analysts said the central bank is likely to lower its rate of 2.25 percent to 2.50 percent by one-quarter percentage point when its two-day meeting ends on Wednesday. A cut would reverse the Fed's recent policy of raising rates.

"The Federal Open Market Committee will almost certainly cut the funds rate on July 31," Goldman Sachs analyst Jan Hatzius said in a research note to investors. "We expect a (quarter-point) move because virtually all the signals from the committee point that way. That said, we cannot rule out a (half-point) move. We currently assign subjective probabilities of 90 percent to a (quarter-point) cut and 10 percent to a (half-point) cut."

The anticipated cut has sparked debate because the economy is strong, and unemployment is at a record low despite an ongoing trade dispute with China that has disrupted the agricultural, retail and high-tech sectors of the US economy.

"Our view remains that the justification for rate cuts is tenuous," the Goldman Sachs analyst said. "Growth, employment and inflation remain close to the Fed's goals." Nevertheless, Hatzius didn't rule out the possibility of another cut in September.

The current economic expansion began in June 2009, and is now the longest in US history. But economic growth dipped to 2.1 percent in the second quarter after growing 3.1 percent annually in the first, a decline of 32.26 percent, the Bureau of Economic Analysis reported.

"It's very important that this expansion continue as long as possible." Federal Reserve Chairman Jerome Powell told the Senate Banking Committee on July 11, during his biannual testimony to Congress. "The US economy is in a very good place, and we want to use our tools to keep it there."

Speaking at a meeting of the Fed's members two weeks ago, John Williams, vice-chairman of the Federal Open Market Committee, said the anticipated cut is intended to head off trouble.

"It's better to take preventive measures than to wait for disaster to unfold," Williams said. "When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress."

In December 2008, the Fed cut rates for the 10th time in 15 months, pushing them below 1 percent for the first time. Housing prices peaked in early 2006, and then began to slip.

In December 2008, the Case-Shiller home price index reported its biggest price drop. Subprime loans made to buyers who couldn't repay their mortgages fueled the crisis.

US President Donald Trump said current interest rates constrain the economy, and he has urged a rate cut. However, the Federal Reserve is independent, and its actions are not subject to review.

On Monday, Trump tweeted: "We are competing with other countries that know how to play the game against the US. A small rate cut is not enough, but we will win anyway!"

In a second tweet, Trump said: "While our country is doing very well, the potential wealth creation that was missed, especially when measured against our debt, is staggering."

The federal funds rate is the interest rate that depositary institutions are charged for borrowing money from the Fed. The rate is used to control inflation or stimulate the economy.

The US core inflation rate, excluding food and energy, is 1.7 percent, or three-tenths of 1 percent below the Fed's target of 2 percent. Inflation remains low despite tariffs, full employment and rising wages.

Fed officials fear that inflation pressure is too weak rather than too strong. That suggests that the so-called "neutral rate" that neither stimulates nor curbs economic growth is lower than in the past. The fear is that low inflation could lead to lower interest rates and leave little room to maneuver in the next downturn.

"We've seen it in Japan," Powell told Congress. "We're now seeing it in Europe. And that's why we think it's so important to defend our 2 percent inflation goal here in the United States, and we're committed to doing that."

The Fed seeks to boost inflation now when the US economy is strong. The Fed believes its 2 percent inflation rate is an indication of steady growth throughout the economy, but it has failed to reach its goal since adopting it in 2012.

By raising rates in a strong economy, the Fed seeks to cool inflation by making it more expensive to purchase goods and services. When the rate is cut, the Fed encourages spending by making it cheaper to borrow. Central banks worldwide follow similar practices.

The stock market typically reacts quickly and positively to a rate cut because lower interest rates encourage growth.

Consumers usually spend more, and companies can fund operations, expansions and acquisitions at lower rates, boosting future earnings. That leads to higher profits and rising stock prices.

Lower interest rates also reduce the cost of issuing bonds to finance expansion. But for investors seeking income from bonds or savings, a rate cut reduces interest payments.

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