The expected move follows clear indications both of a cooling in the US jobs market, and greater confidence that inflation is nearing the 2% target. There is particular concern over slowing rate of jobs growth. “The downside risks to employment have increased,” he said.
A significant minority of market traders are anticipating a cut of 50 basis points. This is unlikely for two reasons: it would be a shock at a time when the Federal Reserve is likely to want to avoid surprises, and it will not want to be seen as politically partisan.
At the beginning of the year, the Republican candidate for the Presidency Donald Trump aired the view that Powell was favouring the Democrats by leaning towards interest rate cuts – although as it turned out the Federal Reserve waited for several months before doing so, rather confirming its neutrality. For this reason however it is likely that there will be no further cut until after the Presidential election in November.
At Jackson Hole Powell emphasized a sober and technocratic approach: “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
A period of calm would be welcomed by many. An increase of 25 basis points in Japan’s interest rate by the Bank of Japan on July 31, combined with softening US economic signals prompted a huge unwinding of positions in the yen carry trade and turbulence on global stock markets.
However, the yen had been depreciating with interest rates at effectively zero, and inflation had returned to the Japanese economy after years of deflation. So a modest interest rate rise should hardly have been a surprise.
Since July 31, the bank has promised there would be no further increases in interest rates while markets are unstable. The Governor of the Bank of Japan, Kazuo Ueda, addressed both houses of Japan’s Parliament on the same day as Jerome Powell’s speech. He confirmed that the bank is prepared to increase rates further if necessary, but that it was “highly vigilant” as regards market conditions. A poll of economists by Reuters pointed to a likely increase in December, not October.
On interest rate policy, the common terms for central bankers who favour a rise is ‘hawks’ while those pushing for a cut are described as ‘doves’. Yet it has always been simplistic to believe that higher interest rates curb growth and that lowering rates guarantees a stimulus.
Ultra-low interest rates can result in misallocation of capital and investment in unproductive assets, causing a drag in growth.
The restoration of significantly positive interest rates in 2022-23 helped rebalance economies. Contrary to some expectations, the increases did not trigger a recession. Unemployment fell to a low of 3.4% in the US in April 2023. On August 18 this year, Goldman Sachs lowered its percentage estimate of the risk of a recession in the succeeding 12 months from 25% to 20%.
The increase from ultra-low rates has indeed raised the cost of government borrowing, a major issue for western economies. And now that interest rates are higher than the prevailing inflation rate, the net tightening effect has become that much stronger.
For Gulf economies, most of which have currencies pegged to the dollar, a cut in the Federal rate will be followed by reduced interest rates locally. Typically there is a slight premium over the Federal rate of around 0.50%.
In the case of Qatar, given its fiscal strength, rising credit rating and improving economic prospects, there is a case to be made to reduce this premium. In the current context, rate cuts are likely to have the effect of a stimulus, given the debt in the real estate sector and the fact that there had not been a local inflationary problem. The Federal Reserve was too late in increasing rates, and should not delay too long in reducing them at this phase of the economic cycle.
Further rate cuts are likely, and probably will be necessary but, as Powell indicates, decisions will ultimately be driven by the data.
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The author is a Qatari banker, with many years of experience in the banking sector in senior positions
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