“We do not know how or when these trade issues will be resolved,” Fed Chairman Jerome Powell said Tuesday. “We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion.”
Economists at Barclays now project the Fed will reduce rates by 0.5 percentage point in September and by another 0.25 percentage point in December. Previously, the bank expected the Fed would be on hold through 2020. Similarly, economists at JPMorgan Chase are forecasting a quarter-percentage-point cut in both September and December, even if the U.S. avoids a lasting trade fight with Mexico.
Yields have tumbled over the past few weeks, a sign investors expect poorer growth prospects and potential rate cuts. The 10-year Treasury is down from 2.426% two weeks ago, and it now sits well below yields on three-month Treasurys, a so-called inversion of the yield curve that has often preceded rate cuts and recession.
Analysts have reassessed their Fed outlooks by incorporating the reaction in bond markets to Mr Trump’s decision last week to impose tariffs on Mexico to push the country to stem Central American migration at the southern border. Senate Republicans threatened Tuesday to block the tariffs, hours after Mr. Trump indicated he was prepared to go ahead with the levies barring a last-minute deal over border security.
The uncertainty reflects the Fed’s predicament. Officials have approvingly cited instances in the 1990s in which the central bank successfully reduced rates to take out “insurance” against a potential downturn. But some officials may be reluctant to make such moves in the current environment in which geopolitical surprises, not economic ones, are the main issue.
Dallas Fed President Robert Kaplan said the speed with which trade tensions have escalated suggests there is the potential for a similarly speedy resolution. “I want to take a little bit more time and be patient here because some of these recent events could be reversed,” Mr Kaplan said in an interview in Chicago. “We’re very cognizant of these downside risks and very cognizant of the change in the shape of the yield curve,” he added.
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