25 or 50 bps? Wrong question and wrong answer

The Fed prognosticators are having a field day ahead of the
upcoming FOMC meeting at the end of July.

If you boil down all the rhetoric to the basics, most
analyses want to know, at least now, whether the Fed will cut rates by 25 or 50
basis points (bps) in July.

There is not much debate about that anymore. Federal Reserve
Chairman Jerome Powell had an opportunity to walk the market expectation back
and he didn’t, almost ensuring a rate cut.

The proponents of a 25 bps move, including me, argue that
the Fed needs to cut rates because inflation is absent, but the underlying
economy is strengthening, so a 25-bps cut should be enough for an initial
gambit. No need for 50 bps today, additional easing may come later.

The 50-bps camp, on the other hand, argues that a 25-bps cut
does not do much for the economy and a 50-bps move ensures the US economy does
not fall into a recession. New York Fed President John Williams fueled a frenzy
of market speculation when he said policymakers needed to act quickly to lower
rates. That of course was later clarified by a New York Fed spokesperson who
claimed he didn’t imply a 50-bps cut.

While the debate is a lot of fun for onlookers, all this
back and forth, unfortunately, brings back memories of the Kremlinologists who
watched the Kremlin balcony on the May Day parade of the old Soviet Union to
see which officials were really in power in the Politburo.

The 25 or 50 bps debate is a similar pointless exercise.

Unless you are a front-end rates trader, the magnitude of
the cut does not really matter.

What matters far more is that the initial Fed cut signals that
the Fed WOULD NOT BE RAISING RATES for a long period of time.

The debate about the 25 or 50bps debate misses the larger
point; the actual impact of rate cuts on the economy is relatively modest.

For a large and diversified economy like the US, a 25 or 50
bps move is unlikely to change the direction of the economy in and of itself.

If the economy is close to a recession, which I believe it
isn’t, even a 50-bps cut would not save it this late in the tightening regime.

Similarly, if the economy was slowing, a 25-bps cut alone is
unlikely to revive the economy.

In reality, if the US economy was in real trouble, and there
was no external stimulus like there was from China in 2015 and 2016, the only
policy action that could save the economy and the markets is large-scale asset
purchases (LSAP) by the Fed. Just look at the European Central Bank (ECB) for
proof – the market expects t the ECB will restart LSAP programs to save an
economy that was on the verge of a recession.

In the current environment, where the underlying economic
momentum in the US economy is quite palpable – 3.7% unemployment, good income
growth, rock-solid consumption, decent but not great investment growth and no
budgetary fiscal consolidation as far as the eyes can see – what is needed and
what the Fed will provide is a signal that they are done tightening and will begin
slowly and methodically unwinding the unwarranted rate hikes of 2017-18.

That message is already coming thru, and the size of
the Fed cut – whether it is 25 or 50 bps – will not change that meaningfully. So
whether it is general secretary Brezhnev in control or Politburo member
Andropov rising to power, it does not matter that much.

In the end, the Fed’s pivot to easier policy is all that was
or is needed. The US economy and global markets are in a better place as a

Important Information

The opinions expressed
are those of the author, are based on current market conditions and are subject
to change without notice. These opinions may differ from those of other Invesco
investment professionals.

Invesco Distributors, Inc. is the US distributor for Invesco
Ltd.’s retail products and collective trust funds, and is an indirect, wholly
owned subsidiary of Invesco Ltd.

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