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Is the US Federal Reserve behind the Curve on Rate Cuts?

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Central banks

On July 2, Australia’s central bank lowered its benchmark interest rate by 25 basis points to a record low of 1%. The bank lowered rates in June as well. Despite record low interest rates, the Australian central bank looks amenable to more easing. It said in a release, “The Board will continue to monitor developments in the labour market closely and adjust monetary policy if needed to support sustainable growth in the economy and the achievement of the inflation target over time.”

The Australian central bank isn’t the only dovish central bank out there. The Indian central bank has cut rates by 75 basis points since December 2018. Turkey has also been cutting rates. The independence of both the Turkish and Indian central banks has recently been under scrutiny.

European Central Bank

Elsewhere, the ECB (European Central Bank) has also signaled further stimulus. Last month, ECB President Mario Draghi said, “The absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.” While markets worry that the ECB doesn’t have the required policy tools given the region’s already low interest rates, Draghi sought to allay fears by saying that the ECB has “considerable headroom.” Japanese and South Korean central banks might also consider monetary easing amid sagging growth.

US Federal Reserve

Meanwhile, the US Federal Reserve has also become dovish after raising rates four times last year to the displeasure of US President Donald Trump. Earlier this year, the Fed abruptly ended its rate hikes. Last month, the Fed signaled that it was open to rate cuts if the situation so warrants it. Looking at the Treasury yields, we can see that the bond markets are already pricing in a Fed rate cut. President Trump has lashed out at Fed Chair Jerome Powell multiple times. Trump wants the Fed to cut rates and end its quantitative tightening. Incidentally, while Trump accused Draghi of suppressing the euro via his stimulus remarks, he praised him in an interview later for his dovish stance.

Is the Fed behind the curve?

Now, is the Fed behind the curve? It did decide to halt the tightening earlier this year. The move surprised markets, as economists didn’t expect the Fed to suddenly end its rate hikes. Now, after solid growth in the first quarter, US economic activity is showing signs of moderation. Multiple data points attest to the looming slowdown. Now, with growth showing more than ample signs of stalling, the Fed could go for a rate cut as soon as this month.

Earlier this year, Berkshire Hathaway (BRK-B) Chair Warren Buffett also discussed a slowdown in growth. Berkshire is underperforming the S&P 500 (SPY) this year. The S&P 500 had its best first half since 1997. Berkshire’s portfolio is overweight in the banking sector. It holds banks such as Bank of America (BAC), Wells Fargo (WFC), and JPMorgan Chase (JPM). Last month, Bank of America, Wells Fargo, and JPMorgan Chase increased their dividends after clearing the Fed’s stress test.

Will it help?

Another pertinent question here is whether rate cuts will actually help propel the economy. After all, growth hasn’t stalled entirely due to interest rates, which by all standards are below what many would view as normalized rates. Globally, monetary policies never really reverted to normal levels, as is reflected in higher fiscal deficits and lower interest rates.

While the Fed’s easing would help maintain the flow of easy money, it might be of little help in terms of actually boosting the economy. Read Does the Fed Have the Pill to Cure a Slowdown? for more analysis.

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