By Christopher Condon
Financial markets have gotten used to the Federal Reserve adjusting its benchmark interest rate in small increments. They might want to be ready for a change.
While no move is expected as officials gather this week, economists and investors generally agree the Fed is going to cut rates this year.
Bets on the Feds next moves got even more complicated Tuesday amid geopolitical turns. Investors first increased bets on a Fed cut after European Central Bank President Mario Draghi said additional stimulus would be needed unless the outlook improved. That prompted President Donald Trump to tweet that Draghi was “unfairly” weakening the euro.
Investors then dialed back rate-cut speculation somewhat after Trump later tweeted encouraging words about U.S.-China trade talks.
The last two times the Fed began an easing cycle, in 2001 and 2007, it opted for a half-percent move over a quarter point adjustment.
If and when the Federal Open Market Committee decides to ease again this year, its members will seriously contemplate doing the same.
Here are the arguments for and against:
For: Surprise, Surprise!
William Nelson, chief economist at the Bank Policy Institute in Washington and a former senior Fed staffer, said policy makers almost always seek to avoid surprises when raising rates but often approach cutting with the opposite aim.
“The FOMC is actually eager to deliver an easing surprise, and in fact at times judge the success of their easing actions precisely by the market impact that only comes from a surprise,” he said.
For: Ahead of the Curve
In their own review of the 25-versus-50 debate, economists at Morgan Stanley pointed out that if the Fed is trying to address looming economic risks, “it makes sense to get ahead of the curve to bolster confidence and leave markets more settled.”
Failing to do so can leave the Fed needing to act again soon and make officials appear too timid, they added in the May note.
For: Gone Too Far
Former Fed Chairman Alan Greenspan frequently argued that the last move in a series of hikes or cuts was often viewed in hindsight as unnecessary.
“Therefore, when we move in a different direction for the first time, its probably wise to remember that the existing level of rates embodies one more move than we needed to do,” he told colleagues on a Jan. 3, 2001 telephone conference call when the Fed delivered a surprise inter-meeting 50-basis-point cut.
Though far from certain, that may end up being true for the Feds December rate hike. The move, when paired with a signal of more increases to come, spooked investors who had begun to worry about slowing global growth.
For: Close to Zero
The target range for the federal funds rate currently stands at 2.25% to 2.5%, which means the Fed many not have enough ammunition to fight a full-blown recession. That makes it more important for the Fed to be aggressive when it cuts, getting the most impact out of every step downward.
“Hitting the zero-lower bound is a problem, so you dont want to hold your fire” in the face of deRead More – Source