E The Federal Reserve Kicks Off The Rate-Cutting Derby

The Federal Reserve kicks off the rate-cutting derby with its decision today to cut the Fed funds rate by 25bps. With the world’s most important central bank taking the lead, we can expect other central banks to follow for reasons that are common to all.

To begin with, there are two over-arching reasons behind the move to lower interest rates. First, developed countries are starting to experience worsening domestic conditions. US business capital investment has been softening and the real concern is that, with the economic expansion now long-in-the-tooth, without new investment economic growth cannot be sustained by the consumer alone. Secondly, more than in any time in the last 30 years, trade wars are now leading to a worldwide slump. So, how are these two issues influencing central bankers?

The Federal Reserve, in its long history, has rarely made policy decisions on the basis of international trade developments. However, that seems no longer to be the case, as Fed speakers have consistently fretted over the potential impact of trade wars with China and the EU that now are starting to be felt throughout the domestic economy.  The Fed stated that “the implications of global developments for the economic outlook as well as muted inflation pressures,” necessitated a rate cut. The Chairman emphasized in his press conference that he was most concerned with these ‘downside risks’ as threats to the outlook.

The Bank of Japan continues to contend with low inflation, currently running at 0.6% annually, despite the presence of negative interest rates throughout its bond market. In addition, the BoJ has been the most aggressive central bank in buying both government debt and selective equities as part of a long-standing program of quantitative easing. It set the standard for QE that has been adopted by the Fed and the ECB. To many observers, the Japanese experience with deflation is a central banker’s worse nightmare, possibly a harbinger of how contemporary economies will evolve as time goes on.

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