Can the Federal Reserve replicate the 2019-style interest rate cuts this time?

Under the background of Trump's "return," can the Federal Reserve respond to potential economic challenges through interest rate cuts like in 2019?

On the 31st, Guan Tao, the global chief economist of Bank of China Securities, published an article stating that the current economic situation in the United States is significantly different from that of 2019, especially with the trade policies of the Trump 2.0 era, which make the challenges faced by the Federal Reserve more complex.

The current U.S. economy is in the later stage of high inflation returning to trend values, meaning inflation has significantly decreased but is still slightly above 2%. The trade policies of the Trump administration could lead to both inflation and economic tightening, which will limit the Federal Reserve's policy space and increase the risk of the U.S. economy falling into difficulties.

"For the Federal Reserve, it may be a case of 'what you fear will come true.' The intensity of the economic and trade friction in the Trump 2.0 era has exceeded that of Trump 1.0, increasing the stickiness of inflation and even triggering the risk of secondary inflation."

Considering the current complex economic situation, the Federal Reserve needs to be particularly cautious in its future policy choices.

Decoding the Federal Reserve's Interest Rate Cuts Six Years Ago

After Jerome Powell took over as chairman of the Federal Reserve in 2018, he continued the interest rate hike policy. However, in the first half of 2019, the Federal Reserve opted to hold steady, and then cut rates three times in the second half of the year. So, what considerations led to those rate cuts at that time? Guan Tao believes it was "in light of the impact of global developments on economic prospects and moderate inflation pressures."

"On the eve of the rate cuts, the U.S. labor market was still strong, the economy was growing moderately, and both overall and core inflation rates remained below 2%, with long-term inflation expectations basically stable. The downside was that the tense global trade situation, geopolitical conflicts, and the rising risk of a no-deal Brexit were likely to drag down U.S. business confidence and corporate capital expenditure plans. However, when the first rate cut occurred on July 31, Powell emphasized that it was merely an insurance or preventive rate cut."

Although the U.S. labor market was strong and the economy was growing moderately at that time, the Federal Reserve still adopted a "preventive rate cut." This rate cut played an important role in the economy: in the second half of 2019, the U.S. real GDP growth rate rebounded, with an annual growth of 2.6% and the unemployment rate remaining low.

However, Guan Tao also pointed out that the rate cuts in 2019 were "a bonus rather than a lifeline." At that time, the impact of the overseas economic slowdown was less than expected, and market risk appetite tended to improve.

Current Risk of Secondary Inflation is High

The article argues that the current economic situation faced by the U.S. is significantly different from that of 2019.

The current U.S. economy is in the later stage of high inflation returning to trend values, meaning inflation has significantly decreased but is still slightly above 2%. According to the latest dot plot, the Federal Reserve has lowered its economic growth forecast for this year but raised its core PCE inflation forecast. The key lies in the trade policies of the Trump 2.0 era. The intensity of the economic and trade friction in the Trump 2.0 era has exceeded that of Trump 1.0, increasing the stickiness of inflation and even triggering the risk of secondary inflation.

Moreover, the tariff impacts in the Trump 2.0 era are broader. A survey by the University of Michigan shows that one-year inflation expectations continue to rise. The tariff policy may lead to retaliatory cycles Previously, the President of the Chicago Federal Reserve warned that if investors in the U.S. bond market begin to expect higher inflation, it would constitute a "significant danger signal."

Considering the upcoming announcement of the "reciprocal tariff" policy, Goldman Sachs has significantly raised the probability of the U.S. economy entering a recession in the next 12 months from the previous 20% to 35%, nearly doubling. Goldman Sachs warned:

"Our increase in the recession probability reflects our lower baseline economic expectations, a sharp deterioration in household and business confidence, and comments from White House officials indicating a greater willingness to tolerate short-term economic weakness to achieve their policy goals."

Beware of the Tightening Effects of Economic and Trade Friction

Guan Tao believes in the dual impact of tariff policies. On one hand, tariffs raise prices by increasing import costs, which has an inflationary effect; on the other hand, tariffs may also dampen economic growth by reducing export demand, which has a deflationary effect.

Although an economic slowdown may create conditions for the Federal Reserve to cut interest rates, the stimulative effect of rate cuts may be limited. More importantly, current monetary policy has its limitations. Powell has pointed out that the Federal Reserve's monetary policy tools cannot address the established roadmap for international trade that businesses desire.

In responding to economic challenges, the effectiveness of monetary policy may be constrained, while the trade policies of the Trump administration have increased the risk of economic downturn. Given the current complex economic situation, the Federal Reserve needs to be particularly cautious in its future policy choices