Powell Tells Us What We Should Already Know

Federal Reserve Chair Jerome Powell delivered opening remarks for the Fed’s “Conference on Monetary Policy Strategy, Tools, and Communications Practices.” Market participants buzzed over the inclusion of this paragraph:

I’d like first to say a word about recent developments involving trade negotiations and other matters. We do not know how or when these issues will be resolved. 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, with a strong labor market and inflation near our symmetric 2 percent objective. My comments today, like this conference, will focus on longer-run issues that will remain even as the issues of the moment evolve.

The inclusion of this paragraph is notable. It looks like a last minute addition. It was clearly intended to send a signal. But what sort of signal?

One take is that Powell intended to signal an imminent rate cut. I do not think this is the case. The consensus view within the FOMC is still that a rate cut would be premature. Instead, the more likely message is that the Fed recognizes the issues currently of concern for market participants and they stand ready to adjust policy as necessary. Vice Chair Richard Clarida added some clarity in a CNBC interview:

“We will put in policies that need to be in place to keep the economy, which is in a very good place right now, and it’s our job to keep it there.”

Both Powell and Clarida are reminding us that the Fed sets policy systematically. If tariffs threaten the economic forecast to an extent that the Fed believes they will not be able to be their mandate, policy makers will act accordingly. This is the case whenever the economy faces a shock, even shocks that are triggered by rash trade policy actions. We should already know this, of course.

In other words, the Fed has little choice but to “bail out” President Trump should his trade policies threaten the economy. That’s how it works. The Fed is not going to let the economy tumble into recession to punish Trump. That would simply be an instance of cutting off your nose to spite your face.

Importantly, Clarida opened up the possibility of an insurance cut:

“I’m not going to look into a crystal ball. I will look into the past,” Clarida said. “That has been in the monetary policy toolkit in the past.”

The implication is that the data does not need to turn recessionary in order for the Fed to cut rates. The data and risks to the forecast only need to suggest a substantial likelihood that the pace of activity will fall below the Fed’s estimate of potential growth (roughly 2%), which in turn would be expected to place upward pressure on unemployment and downward pressure on inflation.

Altogether, the message is that the bar for a rate cut is fairly low. What size of rate cut? If the cut is in fact more insurance than panic, I suspect it will be 25 basis points. If the data gets away from the Fed more quickly than anticipated, it will be 50 basis points. Assuming the economy slows as anticipated in the next few months, inflation remains low, and weaponized uncertainty remains the Trump administration’s primary policy choice, I think a 25 basis point rate cut in September is a reasonable baseline scenario. If the slowdown turns elusive, the odds of a rate cut obviously decline accordingly.

Bottom Line: The Fed stands ready to adjust policy as needed to respond to unexpected shocks; this is true even if the shocks emanate from the White House.