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As Fed approaches rate cut, policymakers debate how deep to trim

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As Fed approaches rate cut, policymakers debate how deep to trim
FILE PHOTO: Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 19, 2019. REUTERS/Leah Millis   -   Copyright  Leah Millis(Reuters)
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By Howard Schneider

CHICAGO (Reuters) – U.S. Federal Reserve policymakers, moving towards their first interest rate reduction in a decade later this month, on Tuesday sketched out arguments for whether rates should be cut by a quarter or a half a percentage point.

The competing strategies laid out by two Federal Reserve regional bank presidents indicated the decision could hinge on whether policymakers want to merely guard against developing risks seen in the world economy and signalled by bond markets, or deliver a solid jolt meant to boost inflation in the United States.

“There is an argument that if I think it takes 50 basis points before the end of the year to get inflation up, then something right away would make that happen sooner,” Chicago Federal Reserve President Charles Evans told reporters at a CNBC economic forum. Evans last week said he felt a half a percentage reduction in the Fed’s target overnight interest rate was needed for the U.S. central bank to deliver on the 2 percent inflation target that it has missed since setting it in 2012.

The Fed set the goal as a way to keep businesses and households forward looking, and help assure a modest pace of price and wage increases. Evans and others are concerned that if they continue to undershoot, they will lose credibility and their statements and policies will become less effective.

The Fed’s current policy interest rate is set in a range of between 2.25 and 2.5 percent.

By contrast, Dallas Federal Reserve President Robert Kaplan, until recently a sceptic that rates should be cut at all, said he now thinks a “tactical” reduction of a quarter point could address the risks apparently seen by bond investors, who have pushed some long-term yields below shorter-term ones.

“If it was appropriate to take action, the best argument for me of why to do that is the shape of the curve,” Kaplan told reporters in Washington, referring to the “inversion” of the bond yield curve , a standard warning sign of recession.

The bond yield curve, when plotted as a graph, inverts from its typical arcing, upward slope when shorter-dated yields exceed those of longer-duration securities.

The differing approaches show how the Fed is edging towards a rate cut at its upcoming July 30-31 meeting without a consensus narrative about why it is needed.

Policymakers have cited international risks, the uncertainty of President Donald Trump’s trade policies, the pricing in bond markets and weak inflation, among other things, as cause to cut interest rates in a growing economy with record low unemployment.

Fed Chairman Jerome Powell, speaking in Paris on Tuesday, reiterated a pledge to “act as appropriate” to keep the U.S. economy humming. But even with the economy continuing to turn in “solid” growth that is helping to keep a “strong labour market,” Powell said with inflation falling short of the Fed’s target and a basket of “uncertainties,” it is harder to remain confident in a still-rosy outlook.

Evans said on Tuesday that each policymaker’s decision on how much to cut may well be shaped by their argument for why to do it.

While higher inflation may require the shock of a deeper cut, he said, “for those who are thinking this is more risk management – a strong domestic economy facing some uncertainty – you could easily argue to go a little slower.”

(Reporting by Howard Schneider; Editing by Leslie Adler)

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