The U.S. economy is growing below its potential but not enough to justify a 50 basis points rate cut at the Federal Reserve’s policymaking meeting next week, according to Mark Zandi, chief economist at Moody’s Analytics.
Zandi, like many economists, expects the Fed will cut the federal funds rate 25 basis points on July 31 though the number anticipating 50 basis points had been growing until recently, including economists at Morgan Stanley.
Feeding those expectations was a recent talk by New York Fed President John Williams suggesting that the Fed “act quickly to lower rates at the first sign of economic distress” because the central bank has limited room to maneuver during a downturn given current low rates. (A spokesman for the New York Fed later walked back Williams’ comments, noting they were “not about a potential policy actions at the upcoming FOMC meeting.”)
Fed funds are now trading in a range between 2.25% and 2.50%, or at roughly half the five-percentage-point rate cut that the Fed engineers during a typical downturn, said Zandi.
Unlike other Wall Street economists, Zandi doesn’t expect the Fed will follow up a rate cut next week with more cuts before the 2020 presidential election, assuming the U.S. doesn’t impose more tariffs on Chinese imports, GDP stays close to 2% and unemployment near 3.5% — which he admits is a “big assumption.”
Zandi calls next week’s expected Fed move an “insurance rate cut,” which are always “unusual except in times of severe financial market stress such as the 1987 stock market crash and the 1998 Asian financial crisis.”
The U.S. is not experiencing a financial crisis and GDP for the first quarter clocked in at a 3.1% annual growth rate.
The market is currently pricing in 78% odds of a 25-basis-point cut and 23% odds of a 50-basis-point cut, according to the CME FedWatch tool. Meanwhile, President Donald Trump continues to tweet that interest rates are too high because the Fed tightened too much, too fast and the Fed should not “miss it again.”
Zandi doesn’t blame the Fed for the slowing economy but rather blames the fading fiscal stimulus — saying the boost from “last year’s deficit-financed tax cuts has largely played out” — along with the U.S.-China trade war and more businesses reducing hiring and/or laying off workers largely because of trade issues, all happening against a backdrop of the longest economic expansion in U.S. history.
“The expansion is thus vulnerable if anything goes wrong,” writes Zandi.
What could go wrong also includes the coming budget battles in Washington, which could involve another potential government shutdown; the upcoming Treasury debt limit; and potential failure by Congress to pass spending legislation before year-end. Also, a no-deal Brexit could cause a European recession and damage to the global economy, according to Zandi.
A budget bill is due by the end of September to avoid another government shutdown, the debt limit agreement near early October. According to news reports, White House and congressional negotiators on Monday were near agreement on new spending levels and raising the government’s borrowing limit.