First Fed rate cut in over a decade

Key fact: The US Federal Reserve lowered its benchmark rate on 31 July to a2.25% from 2.5%.

What caused this? Weak global growth, trade policy uncertainty and muted inflation are the main drivers for the interest rate cut according to Fed chairman Jerome Powell.

Big picture: Global economic outlook remains sluggish which could negatively spill over on the US economy.

The Fed’s Federal Open Market Committee’s decision to lower the federal funds rate for the first time in 11 years might come as a surprise given the strong performance of the US economy. Although GDP is expected to be 2.6% in 2019, US domestic demand is softer than expected and imports weaker as well, in part reflecting the effect of tariffs. These developments point to a slowing momentum. Combined with a subdued global economy, the rate cut is somewhat of a precautionary measure which shows the Fed’s willingness to “act as appropriate to sustain the expansion’’. Economists argue that escalating trade tensions could push the Fed into further rate cuts later this year. According to the IMF’s latest World Economic Outlook, GDP releases so far this year, together with generally softening inflation, point to a weaker-than-anticipated global activity at 3.2% in 2019. Key indicators such as investment, demand and trade are sluggish as firms and households continue to hold back on long-range spending. In the US, business confidence is falling, as non-residential investment shrank in the second quarter of the year while residential investment has fallen for six consecutive quarters. As for inflation, it stubbornly persists below the Fed’s 2% target.

The Fed is facing mounting pressure from multiple sides. Donald Trump, who had called for a more aggressive cut in interest rates, issued a sharp rebuke to the Fed chairman on Twitter. Wall Street will crash without a fresh injection of cheap money. Share prices have reached record levels only because the markets have been banking on a Fed rate cut. The being said, the rate cut is a correction from December’s increase to 2.5%.

Federal Funds rate: interest rate banks charge each other overnight to lend the mandatory funds deposited at the Fed.

Business confidence: indicator used to anticipate future business activity based upon opinion surveys on developments in production, orders and stocks of finished goods in the industry sector.

@Economist & @Guardian

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