Jerome Powell must be relieved about how the Federal Reserve’s first rate cut in more than four years went down with global investors. Markets took his bigger-than-expected 50 basis-point easing move very much in stride.
Had his team been less assertive, easing just 0.25 percentage points, the guesswork about the next move would have started immediately.
Here in Asia, though, economists can’t help but wonder what Fed officials know that global markets don’t. The Fed’s downshift to a range of 4.75%-5%, after all, was of a magnitude usually reserved for a recession or crisis.
“This ‘jumbo’ cut marks a step towards populist monetary policy by the Fed,” says economist David Roche, founder of Global Strategy. “It was wanted by the market, where, of course, the pain threshold is zero. It was dictated by the media. But it is not needed by the [US] economy, which is well-balanced.”
Roche wonders, though, “is the decision particularly intelligent as it places far too much emphasis on the Fed’s employment over inflation goals. It raises doubts about what the Fed knows about the labor market that we don’t. And it indicates that the Fed puts the equilibrium level of interest rates well below the level which the dynamism of the US economy justifies.”
Mark Zandi, chief economist at Moody’s Analytics, notes that Wednesday’s cut “feels overly aggressive, unless you know the economy is going to start to weaken more significantly.”
Economist Ryan Sweet at Oxford Economics wonders if the Fed is admitting, effectively, it should’ve eased sooner.
“The Fed,” he says, “doesn’t like to admit policy errors, but some of the decision for a larger cut in September is likely to get caught up as the central bank found itself behind the curve by one meeting. Therefore, the September decision is a preemptive strike to increase the odds that the central bank can pull off a soft landing.”
The Fed’s inflation calculus will spawn many economic reports in Asia. As Powell’s team admitted in its post-easing statement, inflation remains “somewhat elevated” above the Fed’s 2% comfort zone (the Consumer Price Index (CPI) rose at a 2.5% annualized rate in July).
The Fed’s argument that “risks to achieving its employment and inflation goals are roughly in balance” might have more impact if one of its 12 voting members didn’t disagree.
Fed board member Michelle Bowman wanted a quarter-point cut. The first dissent by a Fed governor since 2005 speaks to the disorientation over why Team Powell went 50 basis points while assuring global markets that all’s well at home.
In Asia, attention now turns to Tokyo. On Thursday, the Bank of Japan began a two-day policy meeting. In late July, it hiked rates to the highest since 2008 — 0.25%. This week, the BOJ is widely expected to leave rates unchanged as economic data suggests sluggish economic growth ahead.
For economists, the game is parsing the BOJ’s language for any hints of more tightening moves later this year. The slightest whiff of another tapping of the brakes could send the yen skyrocketing.
The yen’s roughly 6% jump since July 31 is fueling genuine paranoia in Asian markets. Signs that BOJ Governor Kazuo Ueda might raise rates again this year might cause another unwinding of the “yen-carry trade,” upending asset markets everywhere.
Twenty-five years of holding rates at zero turned Japan into the globe’s top creditor nation. For decades, investment funds borrowed cheaply in yen to bet on higher-yielding assets around the globe.
As such, sudden yen moves slam markets virtually everywhere. It became one of the globe’s most crowded trades, one uniquely prone to correction.
The direction of Fed policy is an equally pivotal variable as China’s economy, Asia’s biggest, slows. That’s particularly so with an apparent rift opening up at Fed headquarters.
“My guess is they’re split,” former Dallas Fed President Robert Kaplan tells CNBC. “There’ll be some around the table who feel as I do, that they’re a little bit late, and they’d like to get on their front foot and would prefer not to spend the fall chasing the economy. There’ll be others that, from a risk management point of view, just want to be more careful.”
There’s a risk, though, that the Powell Fed is putting optics over prudent economic policymaking.
“For the Fed,” says Seema Shah, chief global strategist at Principal Asset Management, “it comes down to deciding which is a more significant risk: reigniting inflation pressures if they cut by 50 basis points, or threatening recession if they cut by just 25 basis points. Having already been criticized for responding to the inflation crisis too slowly, the Fed will likely be wary of being reactive, rather than proactive, to the risk of recession.”
Indeed, the Powell Fed has invited skepticism thanks to the ways in which it bowed to political considerations in the past.
Former US President Donald Trump chose Powell to lead the Fed. Soon after he took the helm in February 2018, however, Powell faced a torrent of Trump demands that the Fed stop raising rates and pivot to easing. Trump even mulled firing Powell, an unprecedented threat to the Fed’s independence.
In 2019, the Powell Fed began cutting rates, pumping fresh liquidity into an economy that didn’t need it. That left the US even more susceptible to post-Covid-era inflation.
The Powell Fed erred again in 2021, arguing that inflation was “transitory” as it delayed rate hikes. In 2022, the need to play catchup on battling rising prices led to the most aggressive Fed tightening cycle since the mid-1990s.
In the interim, the US national debt topped US$35 trillion while political polarization in Washington is fueling fears of increased brinkmanship over funding the government. The Fed’s pivot is surely a boon for the Joe Biden-Kamala Harris White House heading into a November 5 election.
Yet drama within the Fed ranks could cloud the policy outlook. Brad DeLong, an economic historian at the University of California at Berkeley, points out that Bowman hails from a community banking background. As such, the dissent “deserves a raised eyebrow” as Team Powell went big Wednesday.
“Since 1993 there have been only six dissents from the chair’s position by the six other Fed Governors, compared to 71 from the rotating five voting Fed bank presidents,” DeLong notes. “The convention is strongly that Governors vote with the Chair to avoid the potential hit to the Fed’s legitimacy from the possibility that a bank president who is legally a private banker casts a vote that determines what has become core government policy.”
What’s more, DeLong points out, “there has been only one hawkish Governor dissent – until now. The convention is that governors dissent only ‘in extremis,’ when they think the center of gravity of the committee is not taking risks to employment seriously enough.”
That’s why Governor Bowman, a Trump appointee, is “distinctly odd,” DeLong says. “Those holding small-scale community-banker seats on the Board of Governors are rarely the interest-rate hawk fringe outliers on the FOMC. The lived experience of serving as a community banker means that repayment risk drives their institution’s typical portfolio to suffer substantially in recession. And I certainly did not see her as the inflation-hawk fringe of the FOMC.”
Again, Asian policymakers are left wondering what the Powell Fed is seeing that they aren’t. “Despite surveys showing that the consensus is expecting a soft landing, rates markets are pricing in a full-blown recession,” says Torsten Slok, chief economist at Apollo Global Management.
This week’s surprise rate cut by Bank Indonesia was a reminder of how Asian economies are on the frontlines of Fed policy decisions.
During Asia time on Wednesday, even before BI knew what the Fed might do, policymakers in Jakarta slashed the seven-day reverse repurchase rate by 25 basis points to 6%, the first easing step since early 2021.
As BI Governor Perry Warjiyo puts it, “the Federal Funds Rate direction is getting clearer, and the rupiah is relatively stable and even getting stronger.”
The question is whether global markets can expect similar moves among Association of Southeast Asian Nations (ASEAN) economies. “This will increase the attraction of ASEAN,” Nirgunan Tiruchelvam, an analyst at Aletheia Capital, tells Bloomberg. “ASEAN in general and Indonesia in particular stands out in this rate-cutting environment. The region is a haven due to the exposure to commodity prices, a consumer resurgence and high dividends. In the 2007 and 2009 rate cuts, ASEAN was an outperformer among emerging market regions.”
It will take time for traders in top financial centers around the globe to discern where the Fed is headed from here. The hope, of course, is that talk of a US soft landing bears out.
“Inflation appears on track to undershoot the FOMC’s June projections, and the higher prints at the start of the year increasingly look more like residual seasonality than reacceleration,” Goldman Sachs economists write in a note. “A key theme of the meeting will therefore be a shift in focus to labor market risks.”
Asks Jason Draho, head of asset allocation at UBS Financial Services: “When will investors think the Fed is ahead of the curve and proactively exercising its ‘put’? This is the most important question because investors have been implicitly asking that – and hoping for this outcome – all summer long.”
It will surely take time before Asia knows how low the Fed will take rates. But the Fed’s assertive cut this week has policymakers on edge and preparing for more bold moves.
Follow William Pesek on X at @WilliamPesek