WASHINGTON - The U.S. Federal Reserve over the course of its 105-year history has changed monetary policy in reaction to property crashes, war, financial bubbles and policymakers’ gut instincts about where the economy was heading.
But the U.S. central bank is now laying the groundwork for its first policy shift triggered by tweets, as Fed officials grapple with how the ground shifted on May 30 when U.S. President Donald Trump threatened on Twitter to impose new import tariffs on Mexico if it did not agree to curb the flow of migrants across the U.S.-Mexico border.
The U.S. economy did not change much in the days that followed. But Trump’s statements spooked financial markets so decisively, and the threats to the global economy became so palpable, that an interest rate cut of at least 25 basis points has been baked in for the Fed’s July 30-31 policy meeting, a message Fed Chairman Jerome Powell is expected to reinforce when he testifies before a congressional committee on Wednesday.
“The Fed has never disappointed a market with such strong expectations of action,” Joseph Lavorgna, chief economist for the Americas at Natixis, wrote in a recent analysis.
With investors in contracts linked to the Fed’s targeted overnight lending rate putting the probability of a rate reduction at close to 100 per cent, “it would be unprecedented for the Fed to not cut,” Lavorgna wrote.
Powell is scheduled to appear before the U.S. House of Representatives Financial Services Committee at 10 a.m. EDT (1400 GMT) as part of his semi-annual monetary policy testimony to Congress.
The minutes should show the extent to which the thinking at the central bank shifted in the days following Trump’s Mexico tariff threat, and how the discussion was shaped by other concerns including weak inflation.
Powell will return to Congress on Thursday to testify before the Senate Banking Committee.
Though U.S. economic growth remains largely on track and the jobs report for June showed continued strong hiring, the events of May changed U.S. trade policy from something of a sideshow in the Fed’s view to a central concern.
Earlier rounds of U.S. tariffs on trading partners including China had been dismissed as of little macroeconomic importance, with the Fed in early May still anticipating its policy rate would remain unchanged in a range of 2.25% to 2.50% for the rest of the year.
By contrast, the higher tariffs announced against China in early May, a rising sense the world’s two largest economies might not be able to make a deal, and the tariff threat against Mexico all added to the growing feeling that protectionism and higher tariffs were here to stay - at some cost to investment and growth
The case for lowering borrowing costs isn’t fully decided. Reducing rates at this point would be similar to the Fed’s efforts in the mid-1990s to nurse along with a lengthy recovery rather than respond to a looming downturn, and “there’s no immediate need to move,” Philadelphia Fed President Patrick Harker said on Tuesday.
But Trump’s tweets about Mexico had a particularly unsettling impact, touching off enough volatility and doubt about the future that it pushed the Fed toward the very rate cuts Trump has demanded for other reasons.
As Trump tied the threatened tariffs, which would have hit one of the world’s most integrated supply chains, to non-economic demands about immigration, investors over two days knocked about a quarter of a percentage point from the federal funds rate expected at the end of 2019.
That added a full additional rate cut to the one investors already had expected, and added market pressure to the Fed’s growing list of concerns.
At the Fed’s last policy meeting in mid-June, eight of the 17 policymakers saw the need for at least one rate cut by year’s end, and Powell told reporters afterwards that many others were leaning in that direction. The minutes may show how strong that bias has become.
In the Fed’s monetary policy report issued last week ahead of Powell’s testimony, the trade war received its own analysis, a sign of the attention it is getting within the central bank.
Fed staff concluded the rise in world tariffs had a likely “material” impact on the slowdown in global trade last year, and that “uncertainty surrounding trade policy could be leading firms to delay investment decisions and reduce capital expenditures.”
Though the threatened tariffs on Mexico never materialized and China and the United States have agreed to resume talks to reach a trade deal, that “did little to alleviate the uncertainty that Fed officials believe is contributing to cooling momentum in global trade and domestic capex plans,” Deutsche Bank’s U.S. economics team wrote this week.
“We anticipate that Powell will stick with a cautious line,” they wrote.