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Here’s Why the Fed Is So Conflicted on Whether There’s a Recession Coming

September 18, 2019, 8:22 PM UTC

The Federal Reserve cut U.S. interest rates Wednesday by a quarter point in a move that was widely expected by the financial markets. The agency’s policy makers, however, revealed a widening debate over whether further easing in interest rates were necessary to prevent the U.S. economy from slowing further.

Stock and bond benchmarks traded erratically in reaction to the Fed’s move. The Dow Jones Industrial Average intially tumbled on the news but recovered its losses to close up 0.1% at 27,147.08. The benchmark 10-year Treasury note also closed largely unchanged at 1.79%, although it rallied from an intraday low of 1.75% before the announcement. 

The Federal Open Market Committee, following the end of a two-day meeting this week, lowered its benchmark rate 25 basis points to between $1.75% and 2%. The committee’s policy statement Wednesday was largely unchanged from the previous one issued in July, which said the U.S. economy showed signs of strength, but that the agency would “act as appropriate” moving forward.

“Although household spending has been rising at a strong pace, business fixed investment and exports have weakened,” the new statement said. “As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”

That placid language may belie a growing tension inside the Fed over how to act in coming months. On the one hand, signs are mounting that a slowdown in the global economy and rising trade wars around the world could dampen U.S. economic growth. On the other, U.S. consumer spending remains largely undeterred, while the unemployment rate remains at a realatively low 3.7%.

But while the majority of FOMC members voted for the quarter-point cut, there were signs of dissent. Two members voted to keep rates unchanged, while another cast a vote for a steeper 50-basis-point cut.

Financial markets are sharing that spirit of ambivalence. According to CME’s FedWatch tool, trading in Fed fund futures had indicated this morning a 72.7% probability that the Fed would cut rates in the afternoon. For the next Fed meeting, they indicate a 44.9% chance of another quarter-point cut, with a 55.1% chance that rates will remain the same.

The Fed has a “dual mandate” of maximizing employment and maintaining moderate interest rates. When rates are too high, inflation become a risk. When they’re too low, the economy can overheat. That leaves a built-in tension in Fed discussions most of the time. But the disagreements the Fed indicated today reflects the growing uncertainty facing not just the U.S. economy, but in the rest of the world.

That uncertainty is reflected in the sometimes contradictory metrics that investors use to gauge the U.S. economy. Stock indexes are trading near record highs, while the majority of economists foresee a recession by 2021. U.S. consumer confidence remains robust, but U.S. companies are growing cautious about new investments.

On Tuesday, the CEO of FedEx, a company often seen as a bellwether for the global economy, called out such a discrepancy in what sounded like a Cassandra-like warning. “I watch the business press every day and I have to tell you, I think there’s a lot of whistling past the graveyard about the U.S. consumer and the U.S. economy versus what’s going on globally,” CEO Fred Smith told the company’s investors.

Adding to uncertainty are the ups and down of global trade, which has been something of an economic wild card in 2019. The U.S.-China trade war seemed on track for resolution this spring before escalating in the summer—with the outlook as uncertain as ever. The chance of a no-deal Brexit is anyone’s guess as the U.K. navigates a dicey exit from the European Union.

And then there’s the threat posed to the Fed’s longstanding independence as a rate-setting agency. Following the Fed’s latest announcement, President Trump lobbied another angry tweet at what he perceived was inaction on the part of Fed Chairman Jerome Powell.

All of this puts the Fed in a pressure-cooker situation. Fed officials have several weeks before they decide again on whether to cut rates further. If the uncertainty resolves itself before then, their decision-making may become easier. But if the outlook grows even foggier, the ambivalence splitting the FOMC now could grow even wider.

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