The more Trump pressures Powell, the harder it is to cut interest rates; currently, a rate cut by the Federal Reserve equals a rate hike in the market?
The Federal Reserve's interest rate cuts may backfire. A report from Bank of America indicates that premature rate cuts, in the context of inflationary pressures and uncertain fiscal policies, could harm the real economy and deplete policy ammunition. Analysts believe that rate cuts may be perceived as politically driven, leading to an increase in borrowing costs, and the market reaction could mirror the situation on April 21, with significant declines in the stock market and the dollar. The Federal Reserve may need to maintain interest rates at their current levels for a longer period than the market expects
Is the Federal Reserve's eagerness to cut interest rates counterproductive?
According to the Wind Trading Desk, Bank of America stated in a report on May 6 that the eagerly anticipated interest rate cuts by the Federal Reserve could be a double-edged sword. In the context of persistent inflationary pressures, new tariffs, and uncertain fiscal expansion prospects, preemptive rate cuts may not only be ineffective but could also cause substantial harm to the real economy and deplete the Federal Reserve's precious policy ammunition.
Not only unnecessary but potentially harmful
Powell has repeatedly insisted that the Federal Reserve is not in a hurry to cut rates. The April employment report proved that the Fed's patience was the right approach. Although the prevailing view is that, given the strong performance of the labor market, the necessity for the Fed to cut rates has diminished, Bank of America analysts believe that cutting rates at this stage could be counterproductive.
Bank of America analyst Aditya Bhave stated, The transmission of monetary policy to the real economy occurs through borrowing rates, which primarily depend on long-term Treasury yields rather than policy rates. Recently, due to "de-dollarization" trades and concerns over fiscal deficits, the long-term U.S. Treasury market has performed poorly. So, would cutting rates really help lower the yields on 10-year and 30-year Treasuries?
Analysts emphasized, If the Federal Reserve cuts rates preemptively, it essentially presumes that the downward risks to economic growth from tariffs (and related uncertainties) and anticipated fiscal easing outweigh the upward risks to inflation. This is a risky judgment, and due to the Trump administration's calls for rate cuts, the market may view such preemptive easing as politically driven.
What if borrowing rates rise when the Federal Reserve cuts rates?
The market has already previewed the scenario of the Federal Reserve being forced to cut rates early. On April 21, amid growing concerns that Powell might be replaced as Fed Chair (due to Trump's dissatisfaction with the lack of rate cuts), the U.S. stock, bond, and currency markets suffered a "triple whammy," with the stock market and the dollar plummeting, and the yield on 30-year Treasuries rising by more than 10 basis points.
Bank of America believes that if the market perceives the Fed's rate cuts as politically motivated, a similar market reaction could occur again. Even if the yield on 30-year Treasuries remains stable throughout the rate-cutting cycle, this poses a problem for the Fed, as it means that it has already consumed some of its policy tools. This is also another reason why the Fed will likely maintain rates for much longer than the market expects.
This Wednesday, the Federal Reserve again decided to pause rate cuts, and Powell reiterated his stance of not being in a hurry to act. Renowned financial journalist Nick Timiraos, known as the "New Fed Communications Agency," reported that the Fed is facing a difficult choice, needing to decide whether to focus more on the risks of rising inflation or the risks of rising unemployment Timiraos pointed out that this creates more uncertainty for the Federal Reserve—lowering interest rates too early could lead to uncontrolled inflation expectations, while waiting too long could result in an economic recession.
Adam Posen, director of the Peterson Institute for International Economics, warned that a rapid rate cut now would increase the risk that the Federal Reserve would have to reverse its policy and raise rates in a few months. Last year, several allies of Trump criticized that the Federal Reserve's rapid rate cuts were stimulating more persistent inflation risks.
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