Why the Fed could eventually cut interest rates again
Why the Fed could eventually cut interest rates again
On Tuesday, the central bank of China lowered interest rates to boost an economy that’s looking increasingly troubled.
It’s a little unusual to hear about interest rate cuts these days, given that the Federal Reserve and other central banks around the world have been raising rates for well over a year now.
But just the other day, economists at Goldman Sachs predicted that the Federal Reserve itself might start cutting rates by the middle of next year. So what kind of conditions would warrant a rate cut instead of a rate hike?
The Fed has raised its key interest rate, called the federal funds rate, to around 5.5% to bring down inflation, which means there is an end game here.
“If we no longer had a big inflation problem, it would no longer seem necessary to keep the funds rate that high,” said David Mericle, chief U.S. economist at Goldman Sachs — a Marketplace underwriter.
Rates are a lot higher than they’ve been in recent history, and that’s been slowing down the economy.
So if inflation comes down, the Fed might see high rates as a bad thing. “Because it encourages people to make economic decisions that might not make sense in the long run,” Mericle said.
A business owner might put off a purchase or a new project. Hiring might freeze up.
“And if enough people were to defer activity in a coordinated fashion, like everybody together at once, that’s how you end up with a recession,” noted Tim Duy, chief U.S. economist at SGH Macro Advisors and an economics professor at the University of Oregon.
To be clear, Duy said that is not happening right now. The economy is still strong this year, even with high interest rates.
But in 2019, the Fed made a few small cuts to interest rates to keep a strong economy going, said Winnie Cisar, global head of strategy at CreditSights. “They referred to it as an insurance rate cut.”
Back then, unemployment and inflation were low, but global growth was weak. Plus, there was all that trade drama with China.
Forecasters are starting to think the Fed might make a similar decision soon, said Cisar. “More of a fine-tuning of how restrictive does Fed policy actually need to be to generally maintain economic momentum.”
If it does decide to cut rates, the Fed is likely to act slowly and cautiously, Cisar added — to ensure that markets don’t get too excited and to prevent inflation from flaring up again.
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