U.S. Monetary Policy Decisions: The Looming Risk of Recession

U.S. Monetary Policy Decisions: The Looming Risk of Recession

U.S. Monetary Policy Decisions

The Looming Risk of Recession

The chair of the US Federal Reserve –  Jerome Powell – signalled that he may alter his monetary stance by way of decreasing Federal rate in the event of heightened trade tension between the US and China. Mr Powell further noted that he would “act accordingly in order to sustain expansion”. As the uncertainty of trade disputes remains, policymakers are still watching the implications of ongoing development of this dispute for the US economy. The Federal Reserve’s announcement boosted investor confidence as US stocks recorded their second best day of the year and the DOW soared 512 points to finish the day.

The escalation of trade wars between the US and China are increasingly pushing the Federal Reserve towards coming to a decision over whether to take action to support the economy and comfort the shaken financial market through rate cuts. Even though most economists expected Fed policy to remain on hold this year ahead of rate hikes in 2020, a large portion have altered their perception with a recent collapse in trade talks.

Putting trade conflicts with China aside, Trump shocked investors by threatening to impose tariffs on imports from Mexico regarding illegal immigration. The unpredictable use of tariffs by Trump is destroying investor confidence in The US economy as well as the global economy. The unpredictability of tariffs would slow down overseas investment around the world while international businesses are less likely to be scaled given the current situation of escalating trade tension.

Oxford Economics have predicted that the Federal Reserve’s first cut will occur in December, compared to a previous forecast of March 2020. The Bank of America Merrill Lynch’s predicts the Fed to cut rates three times in the coming months, with likely reductions in September, December, and another early in 2020 due to recent economic growth slows down.

Investors are now highly concerned as to whether the Fed might opt to take action pre-emptively to avoid a huge slump in the Market while simultaneously providing the Trump government with a weapon to negotiate even tougher in the trade wars with China.

Being too cautious could be a mistake

During a period of uncertainty and politicised environment, decision regarding US monetary policy could render quite significantly.  As a result, the Fed policymakers would be more cautious about the monetary policy.

Although the GDP for the first quarter is robust at 3.1 percent, analysts suggest that there is very little space for future growth. The difference between GDP and GNI (Gross Domestic Income) is now at the historic high level after the great recession of 2018. On top of the core figures’ slowing down, other business forecasts suggest the trade tension cut the intention of business spending, which implies the public anxiety about the potential recession.

Lawrence Summers, a professor at and past president of Harvard University, noted that “the best way to take out the recession or slowdown insurance would be for the Fed to cut interest rates by 50 basis points over the summer and by more, if necessary, in the fall.” Mr Summers was treasury secretary from 1999 to 2001 and an economic adviser to President Barack Obama from 2009 through 2010. The outcome of a serious recession in the near future is extremely serious because it would reduce American influence worldwide and deteriorate the global economy.

By way of example, the great recession in 2008 should serve as a means of policymakers in the Federal Reserve being too slow to respond to the market shock. Given that in order for monetary policy to take effect, a slow Fed reaction could prove to be costly.

The last year’s core inflation is at 1.6 percent, which poses a situation wherein the Federal Reserve needs to accelerate the economy in order to meet its 2 percent inflation consensus. Mr Summers further criticised that “Sometimes the Fed should worry that overly easy policy will lead to complacency in financial markets”. While adhering to recent volatility in the markets and with the possibility of more adverse surprises on the trade front, this is not such a time.

By way of conclusion, in the likely event that the US central bank would conduct a 25 basis points rate cut around September as Powell implied in the Chicago speech, some markets have already priced the expected change. However, policymakers have been criticised for their slow action to the economic setback, which may trigger another deep recession.

By Frank Zhang

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