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Fed opts for third rate cut at October meeting

Inflation pressures remain low and the labor market is strong

Summary

The rate-setting body noted that uncertainties about the outlook remain, and that it will watch global developments, as well as inflation and employment.

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The Federal Reserve voted to cut its target interest rate a quarter percentage point to the 1.50 to 1.75 percent range, at its October rate-setting meeting – its third rate cut this year.

According to the Fed, “This action supports the committee’s view that sustained expansion of economic activity, strong labor market conditions and inflation near the committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain.”

Even as the Fed has continued cutting rates, credit card rates have not seen much of an impact. For the week of Oct. 30, the average card rate was 17.37 percent, down from 17.80 for the week of July 31, when the Fed made its first rate cut in many years.

The Fed cited “global developments” and “muted inflation pressures” as driving its decision to target a lower interest rate. It also noted that while the labor market remains strong and economic activity has been rising moderately, business investments and exports remain weak. Besides, inflation is still running below the central bank’s 2 percent target.

In contemplating future action on rates, the rate-setting Federal Open Market Committee will consider actual employment and inflation figures, as well as the outlook for these economic indicators, in addition to “readings on financial and international developments.”

In a press conference following the interest rate decision, Fed Chairman Jerome Powell noted that a resolution to trade issues would “bode well,” and improve the risk picture. The “tail risk” of a no-deal Brexit has also been mitigated. The Fed’s outlook is for a moderate 2 percent growth.

See related:  What recent bank earnings say about you, and what to do about it

Fed acting to avoid Japanese-style disinflation

Inflation was still running below the Fed’s targeted 2 percent in August, with the personal consumption expenditures index up 1.4 percent over the year. Excluding unstable food and energy prices, the PCE index rose 1.8 percent from last August.

Powell noted that the Fed would act to hike rates only after there are signs of achieving its “symmetric 2 percent” target for interest rates. Japan has experienced a long period of disinflation, and Europe has also in recent years been affected by disinflation.

“There are significant disinflationary pressures worldwide and we aren’t exempt from that,” Powell said.

Inflation in the U.S. looks to be settling in below 2 percent, with inflation expectations also moving sideways and down. The Fed is considering various innovative ways to keep inflation anchored to its goal, which they will likely come out with in the middle of next year.

Touching on the lack of liquidity in the repurchase money market this summer that forced the Fed to act to maintain its target interest rate, Powell noted that even though some banks had excess reserves, they did not act to invest them to get higher returns in the repo market. The Fed is looking into how to make “liquidity flow better without sacrificing safety or soundness.”

The Fed is also monitoring the financial stability picture. Although some asset prices are high, Powell doesn’t see any bubbles. Households in general are in great shape, but the Fed remains concerned about the historically high debt levels of some businesses.

Economic growth continues

In the third quarter, the U.S. economy grew 1.9 percent, according to the government’s initial estimate of gross domestic product for the period. This is down from the second quarter’s 2 percent growth.

Consumer spending, which accounts for about 70 percent of GDP, continued strong in the third quarter, boosting economic output. Government spending (federal, state and local),  homebuilding and exports were also positives. Business inventory investment slowed down in the third quarter though, together with nonresidential building. A pick up in imports also slowed growth.

In a blog post commenting on third quarter GDP, Diane Swonk, chief economist at Grant Thornton, noted, “Growth pleasantly surprised to the upside in the third quarter, which deals another blow to the rationale for a Federal Reserve rate cut today. Look for at least two dissents if the Fed decides to cut rates a third time this year; at least six of the 12 regional Fed presidents would like to see more signs that the economy is slowing before cutting again.”

Two FOMC members did vote against today’s rate cut; both Esther George and Eric Rosengren preferred to maintain the target rate at 1.75 percent to 2 percent.

See related:  Card balances dipped in August, the Federal Reserve reports

Will job growth slowdown further?

On the employment front, ADP reports, based on its private survey, that the economy added 125,000 private-sector jobs in October.

In the ADP news release reporting on the October job numbers, Mark Zandi, chief economist at Moody’s Analytics, said, “Job growth has throttled way back over the past year. The job slowdown is most pronounced at manufacturers and small companies. If hiring weakens any further, unemployment will begin to rise.”

However, Powell doesn’t see any sign of weakness in other parts of the economy impacting the employment situation, and noted consumers continue to boost the economy. Workers at the lower end of the spectrum are finally seeing the impact of wage gains as the expansion continues, although many people are still not in the labor market yet, Powell said.

And in his daily email commentary, Ian Shepherdson, chief economist at Pantheon Macroeconomics, noted that the ADP numbers are above the consensus expectation for October job growth of 110,000.

He expects that the ADP numbers are overstating job growth, since the firm doesn’t account for a strike at General Motors, and he expects the government report on Nov. 1 to show job growth of only 70,000. In fact, Shepherdson anticipates that job growth will slow to 50,000 by early next year.

 

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