The US Federal Reserve adopts an easing bias

On July 10, Federal Reserve chairman Jay Powell began his testimony to the House of Representatives Committee on Financial Services. On July 11, this was followed by his testimony to the US Senate Banking, Housing and Urban Affairs Committee. During his testimony to the House Committee on Financial Services he indicated that the Fed had moved from a neutral bias to an easing bias.

There were two reasons that he talked about as being central to the changing of the Fed open market committee from a neutral bias to an easing bias. One was inflation and the other was the state of the international economy.

He said that inflation had previously been running at close to the Fed's 2 per cent objective over much of the past year. However, in May 2019, overall price inflation measured by the 12-month rate of change of the personal consumption deflator had declined to 1.5pc. The change in core PCE inflation had declined to 1.6pc.

In his commentary earlier in the year, Powell said he thought this change in inflation was a temporary matter; now he suggested that this low inflation is here to stay. He also talked about the risks that have re-emerged in the world economy. Powell remarked, that at the time of the May meeting, the Fed was mindful of problems in global growth and trade. Still, there was evidence that these problems and cross-currents were moderating.

Powell then went on to say that since the May meeting of the Fed, these cross-currents have re-emerged, creating greater uncertainty. Apparent progress in trade has turned to greater uncertainty. The Fed's contacts in business and agriculture have reported heightened concerns over trade developments. Growth indicators from around the world have disappointed. This raised concerns that weakness in the global economy will affect the US economy.

The market responded to his comments by believing that the Fed would cut at its next meeting. In question time, Powell appeared to support that interpretation. Based on our model, the Fed could provide up to three rate cuts. However, what we think may happen is that the Fed will likely provide one cut of 25 basis points at the next meeting or the meeting after. This would be followed by another cut of 25 basis points a quarter after that. The Fed might then wait another quarter. Should conditions not have improved it might then provide a third and final rate cut.

Should the Fed deliver on these rate cuts, what we have is a dramatic change in circumstances for the US dollar and for commodity prices. A fall in the Fed funds rate will put downward pressure on a very strong US dollar. A decline in the US dollar would put upward pressure on commodity prices. This could in turn allow inflation to again begin to rise.