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Fed cuts interest rates to prop up the slowing economy

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Federal Reserve Chairman Jerome Powell has said he's not predicting a recession, but the trade war could hurt business spending.
Federal Reserve Chairman Jerome Powell has said he's not predicting a recession, but the trade war could hurt business spending.
Andrew Caballero-Reynolds/AFP/Getty Images

The Federal Reserve cut interest rates Wednesday for the second time in seven weeks, in an effort to prolong the decade-old economic expansion in the face of rising headwinds. 

The Fed lowered its target for the federal funds rate by a quarter percentage point, to a range of 1.75 percent to 2 percent. The move, which had been widely expected by analysts, will trim the cost of borrowing for households and businesses. 

"Although household spending has been rising at a strong pace, business fixed investment and exports have weakened," the Fed noted in a statement. Inflation has also remained stubbornly below the central bank's 2 percent target. 

The statement noted that consumer spending remains robust and unemployment is near a 50-year low. But it also highlighted uncertainty surrounding the economic outlook.

Fed Chairman Jerome Powell and his colleagues are responding to signs of slowing economic growth, especially in the manufacturing sector which is sensitive to rising tariffs and slowing growth in overseas markets.

"Uncertainty around trade policy is causing some companies to hold back now on investment," Powell told an audience in Switzerland this month. "So our obligation is to use our tools to support the economy, and that's what we'll continue to do."

Powell and his colleagues also pointed to trade uncertainty back in July, when they cut interest rates for the first time in more than a decade. The stock market wasn't satisfied at the time, in part because Powell seemed to suggest it might be the last rate cut for a while.

Since then, economic indicators have worsened, with the U.S. imposing new tariffs on more than $100 billion in Chinese imports this month, and a tariff increase scheduled for mid-October.

Two members of the Fed's rate setting committee dissented from the cut, preferring to leave rates unchanged. One member voted for a more aggressive cut of a half percentage point.

Many forecasters are anticipating additional rate cuts this year. But even with that extra push from the Fed, economic growth is expected to slow, possibly dipping below 2 percent.

The trade war is not the only economic speed bump. Growth is also slowing in other countries. The effects of the 2017 tax cut are dwindling. And there's growing uncertainty about oil prices after the attack over the weekend in Saudi Arabia.

Nervous about a slowing economy, President Trump has been browbeating the Fed to cut interest rates aggressively, to zero or even lower. Others, including former New York Fed President Bill Dudley, have argued that the central bank should stand pat and let Trump feel the political fallout from the trade war he started.

"Political factors play absolutely no role in our process," Powell insisted in Switzerland. "My colleagues and I would not tolerate any attempt to include them."

The stock market was counting on a rate cut Wednesday and likely would have suffered a sell-off if Powell and his colleagues hadn't delivered. But it's not clear that lower interest rates will do much to help the nation's struggling factories.

"We see the driving force of the slowdown certainly in manufacturing as trade uncertainty," said Matthew Luzzetti, chief U.S. economist at Deutsche Bank. "Cutting the fed funds rate is not going to be able to fully alleviate that uncertainty."

Factories and others have cut back on investment not because it's too expensive to borrow money but because they're not sure they can sell their products. In that environment, Luzzetti said, cutting interest rates can do only so much.

"I think it will help prop up confidence. It will help financial conditions. But it's going to be difficult to fully offset those effects," he said.

Mohamed El-Erian, chief economic adviser at Allianz, agreed that cutting interest rates is unlikely to spur business investment.

"Lower interest rates would be like pushing on a string," he said.

What would help is an end to the trade war. And in recent days there have been signs of a possible thaw in trade relations between the U.S. and China. Trump delayed raising tariffs on Chinese imports by two weeks, and China waived some tariffs on U.S. farm products. Still, it's not clear a wider trade truce is imminent.

"Right now that's all talk," said Kathy Bostjancic, chief U.S. financial economist at Oxford Economics. "We have seen that before. We've seen encouraging talk. And then both the markets and business leaders and consumers — everyone — ends up being disappointed. Because not only is there no trade truce. It actually ends up being ratcheted higher." 

Copyright 2019 NPR. To see more, visit https://www.npr.org.