Should the Federal Reserve meet market expectations and signal a rate cut at its meeting Wednesday, the move will come under some unusual circumstances. Normally, when the Fed starts loosening policy it does so amid clear-cut signs of economic weakness. The last time it entered a cutting cycle was September 2007. At that juncture, the subprime mortgage crisis had displayed clear signs of accelerating. The Federal Open Market Committee in its post-meeting statement noted that "the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally." The half-point cut was aimed at heading off "some of the adverse effects" from the housing issue that had caused "disruptions in financial markets."

Finally, the statement cited "uncertainty surrounding the economic outlook" as a reason to begin an easing cycle that wouldn't stop until the central bank took its benchmark rate all the way from 5.25% to nearly zero. No such conditions are present today. At its most recent meeting, the committee declared the labor market "strong" and said the economy is growing "at a solid rate." Public statements since then have cited some concern over trade issues and a few other issues. The closest thing to any outright worry about the pace of the history-making economic expansion came from Chairman Jerome Powell, when he said on June 4 that, "We are closely monitoring the implications of these [trade] developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective." Yet the Fed is still expected to signal that it will start cutting, possibly as soon as July. The futures market is pricing in up to three quarter-point reductions before the end of the year. At the core of the market's concern are two issues: the uncertainty over the various tariff battles in which the U.S. has found itself with China and other trade partners, and the inverted yield curve, where short-term government bond yields are now higher than the benchmark 10-year note, in the past a strong signal of an impending recession. And then there's inflation: market participants — and President Donald Trump — think there's no reason for the Fed to have rates where they are with the Fed consistently missing its 2% inflation target. "The Fed should only want to be restrictive when it is seeking a disinflationary slowing of the economy," said Paul McCulley, a former Pimco executive and now senior fellow in financial macroeconomics at Cornell Law School. "By definition, this cannot be the case when the Fed has missed its inflation target on the low side for a decade."

Back to the 'New Neutral'