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Column: Fed wrestles with signs of a slowing economy

LONDON (Reuters) - The Federal Reserve’s track record suggests policymakers are likely to cut interest rates during the third quarter of 2019, if signs of a slowdown are confirmed, although cuts could come faster if financial conditions deteriorate.

Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 19, 2019. REUTERS/Leah Millis

The Federal Open Market Committee (FOMC) normally needs several opportunities to review incoming economic data before deciding to ease monetary policy in response to signs of slowing growth.

Quarterly and monthly economic data is often contradictory and volatile, so policymakers need a few months of numbers to spot a change in trend and separate the signal from the noise. This is known as the “recognition lag”.

Policymakers may also need several discussion sessions and time to challenge previous assumptions and build a consensus around a new course of action, known as the “decision lag”.

Because of these recognition and decision lags, the Fed almost always acts with a delay to signs the economy is nearing recession.

In the run up to interest rate reductions in 1990, 1998, 2001 and 2007, the FOMC met three to six times between first noting signs of slowing growth and making the first rate cut.

In 1990, for example, the committee first noted “economic activity was continuing to expand but at a relatively slow pace” at the start of July, although the decision to ease pressure on reserve conditions was not taken until the middle of November.

In 2000, the committee noted “softening in business and household demand” in mid-November but the decision to cut interest rates was not taken until the start of January.

The committee normally meets eight times each year at intervals of approximately six weeks, so the three-to-six meeting lag translates into a delay of between two and six months.

But when weakness is driven by an abrupt deterioration in financial conditions, the committee has held extra unscheduled meetings by conference call, compressing the timetable.

In 1998, the committee first noted weakness in June, then held a regular meeting in August, an emergency call in September, and cut interest rates a week later.

In 2007, the committee observed “downside risks have increased somewhat” in early August, then held two emergency conference calls later that month, before cutting interest rates at a regular meeting in September.


This year, the committee first acknowledged problems obliquely after its meeting at the end of January and then more explicitly at its recently concluded meeting on March 20.

In January, the committee only made a very brief reference to “global economic and financial developments” in justifying why it would be “patient” before deciding on future policy moves.

By March, the committee was more direct in noting that “the growth of economic activity had slowed from its solid rate in the fourth quarter”.

“Recent indicators point to slower growth of household spending and business investment in the first quarter,” it added (“Federal Reserve issues FOMC statement”, March 20).

The committee’s next scheduled meetings are due at the end of April, the middle of June, the end of July and the middle of September.

There is no guarantee the Fed will cut interest rates in 2019, and the current bout of weakness could prove to be a transitory soft patch.

But the yield curve is inverting, and bond markets are already pricing in the possibility of rate reductions in the final quarter of the year and more probably in 2020.


The yield spread between three-month and 10-year U.S. Treasury securities has shrunk to its lowest level since the global financial crisis started to erupt in August 2007.

Yield curve inversions have been the best predictor of recessions over the last 60 years, according to models developed by the Federal Reserve Bank of New York.

At the same time, yields on 10-year U.S. Treasury Inflation Protected Securities have halved over the last four months as investors look for a safe haven.

If the recent slowdown in the rate of expansion is confirmed and the Fed decides to respond by cutting interest rates, experience suggests the decision is most likely to be taken between mid-June and mid-September.

But the timetable could be accelerated if economic conditions deteriorate faster than expected or there are signs of financial stress, in which case the committee could convene by conference call to expedite the process.

John Kemp is a Reuters market analyst. The views expressed are his own.

Related columns:

- Oil and equity markets prepare to party like it's 1999 (Reuters, March 19)

- Fed's next move more likely to be a cut in interest rates (Reuters, March 7)

- Investors are digging in for an age of anxiety (Reuters, Feb. 27)

- Slowing U.S. economy can ill afford any more shocks (Reuters, Feb. 19)

Editing by Edmund Blair