Fed faces crossroads as it weighs third rate cut

Fed faces crossroads as it weighs third rate cut
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The Federal Reserve is expected to cut interest rates for the third consecutive meeting Wednesday to boost a slowing economy despite growing concerns it could be depleting its arsenal of tools to fend off a recession.

The Federal Open Markets Committee (FOMC), the Fed’s policymaking arm, finds itself at a difficult crossroads ahead of the Tuesday start of its two-day October meeting.

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The U.S. economy has slowed steadily throughout 2019, though the country still boasts joblessness near historic lows amid a record stretch without a recession. Even so, the October jobs and third-quarter growth reports are likely to show the U.S. economy heading toward a plateau, raising pressure on the Fed to cut rates to spur activity.

Economists say the Fed is almost certain to slash borrowing costs as monthly job gains fall and Europe braces for a potential recession. Fed watchers also cite the looming threat of new U.S. tariffs on Chinese and European goods, along with widespread geopolitical unrest, as major risks to the U.S. economy.

“The weakness has already commenced,” said Daniel Alpert, managing partner at investment firm Westwood Capital. “We’re already seeing it in the data. So what are you going to do, wait until everybody’s flat on their backs?”

But with interest rates already close to record lows, skeptics of the Fed’s loose-money approach question whether another cut will protect the U.S. from a more severe downturn and instead leave the bank defenseless against a true recession.

“They’re already very close if not below the real inflation-adjusted zero lower bound,” said Karen Shaw Petrou, managing partner at Federal Financial Analytics, referring to the level at which interest rates are effectively equal to zero.

“What I would call ultra-accommodative policy gives the Fed very little ammunition with which to counter a real macroeconomic slowdown,” Petrou continued.

The Fed’s difficult decision comes as the bank faces intense political pressure from President TrumpDonald John TrumpFive takeaways from the Democratic debate As Buttigieg rises, Biden is still the target Leading Democrats largely pull punches at debate MORE. The president’s years-long campaign to bully the Fed into zeroing-out interest rates, and blaming it for any economic setback, has plunged the independent bank into a risky political battle.

Fed Chairman Jerome Powell has largely dismissed Trump’s attacks while asserting the bank’s independence from the administration. But Trump has ramped up his scapegoating of the Fed as an economic slowdown threatens his presidency.

Trump tweeted Thursday that the Fed would be “derelict in its duties” if it doesn’t match rates set by central banks in Europe, including Germany, where interest rates are negative.

“Take a look around the World at our competitors. Germany and others are actually GETTING PAID to borrow money,” Trump tweeted. “Fed was way too fast to raise, and way too slow to cut!”

Powell must also deal with a Fed board increasingly divided over interest rate policy, where some members are opposed to a third cut.

The U.S. has maintained higher interest rates than other advanced economies due in part to the country’s relatively stronger and quicker recovery from the 2008 recession. The Fed raised rates four times in 2018 amid a burst of economic growth, following five hikes between 2015 and 2017.

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Trump had blasted the Fed as it tightened interest rates in a bid to stave off inflation, which the bank feared would soon spike as the unemployment rate declined. But as the economy slowed and inflation stayed low, the Fed halted rate hikes in January, then cut rates in July and September amid rising fears of a recession.

“There were two main reasons for the September rate cut: the downside risks to the outlook because of the trade tensions, and muted inflation. Neither of these has changed significantly since that meeting,” wrote Ryan Sweet, director of real-time economics at Moody’s Analytics, in a Friday research note.

While recession fears have eased slightly since the summer, the road ahead is still laden with threats for the U.S. economy.

A temporary tariff truce between the U.S. and China did not address whether Trump will go through with plans to impose steep tariffs on Chinese-made consumer goods on Dec. 15. Trump must also decide next month whether to go through with tariffs on foreign autos and auto parts, which could devastate the European and Mexican economies.

The lingering financial risks of a no-deal Brexit, violent suppression of pro-democracy protests in Hong Kong and political crises across the Middle East also threaten to tip the U.S. toward a recession, analysts say.

Despite the potential risks ahead, a Monday stock market rally pushed the S&P 500 index to a record high as Wall Street regained its composure after a summer sell-off. Renewed faith in trade talks and the potential of a fourth-quarter rebound has also prompted some economists to call on the Fed to hold steady for now.

“Easing into a market moving into record territory will stoke bubbles. There could be a better time to cut rates,” tweeted Diane Swonk, chief economist at Grant Thornton. “The economy is slowing, but not enough yet to justify another cut.”

While Alpert says he supports another rate cut, he ceded that the “boost from cutting rates today will be nowhere near as great as it was the last time we returned to the zero lower bound,” citing overinflated asset prices.

And Petrou stressed that another cut could leave the Fed with little room to respond if one of the many risks facing the U.S. causes a widespread recession.

“This is a very dangerous strategy, emptying out the Fed’s toolkit,” Petrou said.