MNI PREVIEW: Fed Readies Preemptive Cut to Bolster Inflation

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve is poised to ease policy next week

in an effort to preempt any further slippage in inflation, joining other central

banks in offering fresh stimulus to economies suffering the effects of trade

tensions and geopolitical uncertainty.

     The FOMC will likely reduce rates by a quarter point to a target range of

2.00%-2.25% at its meeting Wednesday and retain guidance that it will "act as

appropriate" to sustain the economic expansion, with additional rate cuts if

necessary.

     Policymakers may opt to leave the balance sheet normalization plan largely

untouched, allowing runoffs to end in September as planned. If instead they

brought forward the end date for runoffs, there would be only modest impact on

Treasuries reinvestments this year.

     --QUARTER-POINT CUT

     Chair Jay Powell signaled the FOMC was gearing up for a rate cut at his

testimony to Congress this month in which he made a case for somewhat easier

policy in light of concerns over global growth and the risk of a persistent

shortfall in inflation from the Fed's 2% target.

     Although futures markets continue to factor in some possibility of a larger

50-basis-point cut next week, several Fed officials have signaled that such a

move would be overdone in light of still-positive economic data. While inflation

continues to run below 2%, unemployment is low and growth remains moderate.

     New York Fed President John Williams appeared to lend support to a

half-point cut last week when he suggested that quick and aggressive action

would be warranted at the first sign of economic distress, since the Fed has

only limited room to cut before hitting the effective lower bound. But after a

dramatic market reaction, the New York Fed issued a rare clarification that his

remarks were "not about potential policy actions at the upcoming FOMC meeting."

Markets quickly reversed course.

     Jim Bullard, the St. Louis Fed chief who dissented from the FOMC's decision

to leave rates unchanged in June, has also said the current situation does not

call for an aggressive 50-bps move.

     --EVOLVING REACTION FUNCTION

     Near-term policy moves may also hint at changes in how Fed officials

approach inflation targeting, former Atlanta Fed president Dennis Lockhart told

MNI this week.

     The Fed's ongoing review of how it achieves its inflation target may

already be leading to a more proactive policy stance, he noted. Policymakers are

mulling whether it might be useful to target 2% inflation on average over a

given period rather than at a point in time. That would suggest that the Fed

would be willing to consider further rate cuts this year if inflationary

pressures remain muted.

     A small cut now would allow policymakers time to judge the effects of their

actions and buy time to see how trade talks develop and business sentiment

evolves.

     And if the downside risks don't materialize, a resulting strengthening in

aggregate demand and stronger inflation would be a good outcome for the Fed.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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