The Ups and Downs of the Federal Reserve
July 2019 will be remembered as the month the United States Federal Reserve showed its determination to fight the sluggish inflation numbers still hanging around an otherwise buoyant US economy.
The Fed warned Congress that depressed prices could lead, by an inevitably, to an “unhealthy dynamic” of lower interest rates. This could mean that if a downturn in the economy was to come – and there are few signs it will – but if it did come then it leaves little room for ways to boost the economy as it tries to fight its way out of such an unhappy position – one not known for the last few years.
If you are going to come and work, and live, in the United States then you have to know about things like the Federal Reserve. The Federal Reserve System is the central bank of the United States. It was founded by the US Congress in 1913 “to provide the nation with a safer, more flexible, and more stable monetary and financial system.” So says the Fed’s website. Many across America would raise an eyebrow to the claim that it provides stability especially in this past turbulent decade. The website goes on: “Over the years, its role in banking and the economy has expanded.”
An understatement! But you do need to know about such institutions and how they work and how they affect the economy, as well as differing views on the actions of the Fed, some complimentary others less so.
The current head of the Fed is Jerome Powell. He took office in Feb. 2018, nominated by President Trump. His priority is to keep inflation under control while the economy expands. But inflation is volatile across the globe. Therefore, it is going to be interesting to see how the US responds to these global pressures. “We’ve seen it [deflation] in Japan. We’re now seeing it in Europe,” Powell said recently, “And that’s why we think it’s so important that we defend our 2 per cent inflation goal here in the United States and we’re committed to doing that”.
Good business growth needs all that we have praised over the last weeks: rising wages and job creation, allied with a robust market. But the treat of crashing inflation remains like some ghost in the background, no one really sure if its there or not, and if it is it going to appear soon. Thus the Fed has a target around 2per cent and that’s where it would like the US economy to be.
So this week the 66-year-old former investment banker and private equity executive who took the helm of the Fed last year made the expected cut in interest rates. The US central bank first interest rate cut since the financial crisis brought the Federal Reserve’s down a 0.25 percentage point taking the federal funds target range to 2-2.25 percent.
In theory cutting interest rates makes borrowing money cheaper for businesses and consumers alike.
But not everyone was impressed. In a tweet, President Trump sounded less enthusiastic than he has been about the Fed chief: “As usual, Powell let us down.” “What the market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China,” tweeted Mr Trump.
Nevertheless, Powell justified the need for looser monetary policy by citing “uncertainties.” Doubtless he was referring to ongoing trade tensions and a weaker global economy both leading to a gloomier economic forecast than usual. The still simmering trade dispute with China has abated somewhat but it would not take much to see it ignited again. In the current political environment things are never dull, or as the Chinese say: may you live in interesting times!
But the persistence of low inflation in the US economy despite high growth and plentiful jobs is a dominating factor behind the decision to cut rates by 25 basis points. The Fed’s preferred measure of inflation – the core price index, which excludes food and energy – is running at 1.7 per cent year-on-year compared with the central bank’s target of 2 per cent.
The curious thing is that even with trade tariffs and full employment plus the added factor of fiscal stimulus the US economy still can’t reach the Fed target of around 2 percent. If the economy tanks, an unlikely proposition, but if it did then the risk is deflation rather than inflation.
Inflation may be good short term for prices and those who set them, longer term a downward inflationary spiral is bad news all round especially for jobs. Deflation is more to be feared right now. A sluggish economy with no growth and depressed prices is no one’s idea of a good time.
More worryingly perhaps the latest Fed announcement on interest rates sent shivers through all the main stock market indexes on Wall Street, all closing down more than 1%.
“So what’s this got to do with me?” I hear you say.
Well, as I said you need to stat to know a little about this type of thing if you are planning to do business in the US and with Americans. This is the sort of thing that US businesses watch. You need to as well.
Business and economies are built, to some degree at least, on business confidence. The recent Fed cut spoke not of confidence but of caution. And that is something we all have to be wary of.
That said what ever you think of the current incumbent of the White House one thing is beyond doubt the US economy has stormed ahead in the last three years. Some of that is down to his confidence in the American economy and the people working in it. Don’t underestimate that. At the end of the day, Fed interest rates – either rises or falls – make the news for a few minutes, if at all. Most if this stuff does not register with the great majority of people though. Tweets from President Trump do – especially with his millions of tweeter followers. But more importantly he sets the tone, the mood for the whole country. And Trump has one setting for that: definitely upbeat.
In Britain recently we said good-bye to the lack luster and frankly depressing figure of Theresa May. Although, to be fair, under her premiership during these past three years the British economy did well in terms of jobs and growth, it never felt that way. Due to Brexit, but in no small measure to May herself, it all felt a bit, well, depressing.
What’s been called the Boris Bounce is happening. Why? Because like Trump across the Pond Boris knows that confidence is born out of feeling confident. True in life, true in business.
That’s why both sides of the Atlantic I have no doubt we are heading for a time of growth. But whereas the political situation in Europe, especially in the UK, is unsettled that is not the case in the US. So, for my money, that’s the economy where the straightforward upward economic growth is going to continue to happen.
So the question is: are you ready to take advantage of that by either trading with or moving to the United States?
