25 or 50 bps? Wrong question and wrong answer

What matters is the Fed signals no rate hikes for a long period of time

The Fed prognosticators are having a field day ahead of the upcoming FOMC meeting at the end of July.

If you boil down all the rhetoric to the basics, most analyses want to know, at least now, whether the Fed will cut rates by 25 or 50 basis points (bps) in July.

There is not much debate about that anymore. Federal Reserve Chairman Jerome Powell had an opportunity to walk the market expectation back and he didn’t, almost ensuring a rate cut.

The proponents of a 25 bps move, including me, argue that the Fed needs to cut rates because inflation is absent, but the underlying economy is strengthening, so a 25-bps cut should be enough for an initial gambit. No need for 50 bps today, additional easing may come later.

The 50-bps camp, on the other hand, argues that a 25-bps cut does not do much for the economy and a 50-bps move ensures the US economy does not fall into a recession. New York Fed President John Williams fueled a frenzy of market speculation when he said policymakers needed to act quickly to lower rates. That of course was later clarified by a New York Fed spokesperson who claimed he didn’t imply a 50-bps cut.

While the debate is a lot of fun for onlookers, all this back and forth, unfortunately, brings back memories of the Kremlinologists who watched the Kremlin balcony on the May Day parade of the old Soviet Union to see which officials were really in power in the Politburo.

The 25 or 50 bps debate is a similar pointless exercise.

Unless you are a front-end rates trader, the magnitude of the cut does not really matter.

What matters far more is that the initial Fed cut signals that the Fed WOULD NOT BE RAISING RATES for a long period of time.

The debate about the 25 or 50bps debate misses the larger point; the actual impact of rate cuts on the economy is relatively modest.

For a large and diversified economy like the US, a 25 or 50 bps move is unlikely to change the direction of the economy in and of itself.

If the economy is close to a recession, which I believe it isn’t, even a 50-bps cut would not save it this late in the tightening regime.

Similarly, if the economy was slowing, a 25-bps cut alone is unlikely to revive the economy.

In reality, if the US economy was in real trouble, and there was no external stimulus like there was from China in 2015 and 2016, the only policy action that could save the economy and the markets is large-scale asset purchases (LSAP) by the Fed. Just look at the European Central Bank (ECB) for proof – the market expects the ECB will restart LSAP programs to save an economy that was on the verge of a recession.

In the current environment, where the underlying economic momentum in the US economy is quite palpable – 3.7% unemployment, good income growth, rock-solid consumption, decent but not great investment growth and no budgetary fiscal consolidation as far as the eyes can see – what is needed and what the Fed will provide is a signal that they are done tightening and will begin slowly and methodically unwinding the unwarranted rate hikes of 2017-18.

That message is already coming through, and the size of the Fed cut – whether it is 25 or 50 bps – will not change that meaningfully. So whether it is general secretary Brezhnev in control or Politburo member Andropov rising to power, it does not matter that much.

In the end, the Fed’s pivot to easier policy is all that was or is needed. The US economy and global markets are in a better place as a result.

Important Information

The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds, and is an indirect, wholly owned subsidiary of Invesco Ltd.

Krishna Memani serves as the Vice Chairman of Investments for Invesco. In 2009, Mr. Memani joined OppenheimerFunds, which became part of Invesco in 2019. Before he joined OppenheimerFunds, he was a managing director at Deutsche Bank, heading US and European credit analysis. Earlier, he headed global credit research at Credit Suisse; was in charge of high grade and high yield portfolios at Putnam Investments; and was a credit analyst at Morgan Stanley.

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