Federal Reserve Chairman Jerome Powell yesterday did not use his Congressional testimony to walk back market expectations for easier policy. Instead, he effectively confirmed that the Fed intended to cut rates at the end of this month. The Fed is taking out insurance against increasing downside risks given that the cost of that insurance is cheap given low inflation. Eventually future rate cuts will have to be about the data not just the risks.

Powell left little doubt about his policy intentions. Importantly, Powell said that the  downside risks that had vexed the Fed at the June FOMC meeting had not waned. Those downside risks – predominantly trade issues and global growth – threaten to weigh on the economic outlook. Actually, more than just threaten as Powell suggested that the downside outcomes of those risks may already be visible in the data. Looking at the minutes of the June meeting, it appears that the most worrisome of those risks was the decline in investment activity as firms responded to the more uncertain trade environment. This is not expected to be a short-term issue; firms now view this uncertainty as not ending anytime soon.

I believe there is more at play than just the downside risks. The Fed has gradually shifted a key component of its underlying framework. They are very much less worried about the potential for an outbreak of inflation. I think it is tempting to describe this as the death of the Phillips curve, but that would be too dramatic. More accurately I think is that the Fed has little faith in their estimates of the natural rate of unemployment, the rate that is consistent with stable inflation.

Prior to this year, the Fed has held stubbornly to the belief that unemployment must rise from these levels if inflationary pressures were to remain contained. But low unemployment had yet to trigger higher inflation and by the March Summary of Economic Projections the median interest rate forecast no longer assumed the Fed would need to rates above neutral to slow the economy and ease unemployment higher. That reflected less confidence in their estimates of the natural rate of unemployment and more emphasis on actual over expected inflation outcomes.

In addition to less confidence about the value attached to the natural rate of unemployment, the Fed increasingly recognizes the value of persistently low unemployment. Both of these issues were visible in Powell’s responses to questions yesterday. This meant the Fed had become more cautious about derailing job growth via higher interest rates and more willing to risk somewhat higher inflation to sustain the expansion.

These shifts, couple with evidence of a slowing economy, allowed the Fed to shift to neutral and stop hiking rates as had been expected just last December.  What pushed them over the edge to a rate cut was the potential disruption triggered by President Trump’s repeated use of tariffs as a negotiating club. The uncertainty caused by the actions was sapping business confidence and threatening to force force to endure the costly process of reworking current global supply chains. The Fed felt they had little choice but the respond with lower rates just as they would with any adverse economic shock.

In other words, Trump got the Fed to cut rates, but had to damage the economy to do it.

Bottom Line: The Fed will cut rates 25bp cut this month; I still think 50bp would be too high given that this is an insurance cut rather than a reaction to the data. Considering the shift of dots in the June SEP, the odds favor that the Fed follows with another 25bp. Beyond that depends on the extent to which the economy is able to manage the Trump trade shocks.