Bank of America warns that if the Federal Reserve cuts interest rates preemptively, it would be tantamount to making an early determination that the combined effects of tariffs and expected fiscal easing pose greater downside risks to economic growth than upside risks to inflation. A Fed rate cut may not necessarily lower US long-term bond yields. Given the backdrop of Trump's repeated pressure on the Fed to cut rates, a preemptive rate cut could also harm the Fed's independence. In the face of unclear trade negotiations, a preemptive rate cut may not only be ineffective but could also deplete the Fed's valuable policy ammunition.
Is the Federal Reserve's eagerness to cut interest rates counterproductive?
According to news from the Trading Floor, Bank of America stated in a report on May 6 that if the Federal Reserve cuts interest rates preemptively, it would indicate an early determination that the combined effects of tariffs and expected fiscal easing pose greater downside risks to economic growth than upside risks to inflation. In the face of unclear trade negotiations, a preemptive rate cut may not only be ineffective but could also cause substantial harm to the real economy and deplete the Fed's valuable policy ammunition.
Meanwhile, a rate cut by the Federal Reserve may not necessarily lower US long-term bond yields (10-year, 30-year). Considering the backdrop of Trump's repeated pressure on the Fed for rate cuts, a preemptive rate cut could also harm the Fed's independence.
A rate cut may not necessarily lower long-term bond yields.
Powell has previously insisted multiple times that the Federal Reserve is not in a hurry to cut rates. The April employment report proved that the Fed's patience was the right approach.
Despite the high demand for rate cuts from the outside, Bank of America Analyst Aditya Bhave believes that cutting rates at this stage may be counterproductive.
First of all, a rate cut by the Federal Reserve may not necessarily lower US long-term bond yields.
The transmission of monetary policy to the real economy is achieved through lending rates, which mainly depend on long-term government bond yields rather than policy rates. Recently, due to "de-dollarization" trades and concerns about the fiscal deficit, the long-term USA government bond market has performed poorly. So, does lowering interest rates really help reduce the yields of 10-year and 30-year government bonds?
Analysts emphasize that if the Federal Reserve pre-emptively lowers interest rates, it essentially denotes a prior determination that the downward risks to economic growth from tariffs (and associated uncertainties) and anticipated fiscal easing outweigh the upward risks to inflation. This is a risky determination.
What happens if borrowing rates actually rise when the Federal Reserve cuts rates?
Secondly, a pre-emptive interest rate cut could harm the reputation of the Federal Reserve's independence. Since the Trump administration has called for rate cuts, the market may view this pre-emptive easing policy as politically driven.
Bank of America believes that if the market perceives the Federal Reserve's rate cut as politically motivated, a market reaction similar to April 21 could occur again.
On April 21, amidst heightened concerns that Powell might be replaced as the Federal Reserve Chair (due to Trump's dissatisfaction with the lack of a rate cut), the USA stock, bond, and currency markets faced a "triple kill," with the stock market and the dollar significantly declining, and the 30-year government bond yield rising by more than 10 basis points.
Bank of America emphasizes that even if the "tragedy" from April 21 does not repeat, if the 30-year government bond yield remains stable throughout the entire rate cut cycle, it poses a problem for the Federal Reserve, as it indicates that a portion of its policy tools has already been exhausted. This is another reason why the Federal Reserve will likely keep interest rates unchanged much longer than the market expects.
This Wednesday, the Federal Reserve decided again to pause interest rate cuts, and Powell reiterated the stance of not rushing to act afterwards. Renowned financial journalist Nick Timiraos, known as the 'New Federal Reserve Correspondent', published a report stating that the Fed is facing a difficult choice, needing to decide whether to focus more on the risks of rising inflation or the risks of rising unemployment.
Timiraos pointed out that this creates more uncertainty for the Fed—cutting rates too early could lead to uncontrollable inflation expectations, while waiting too long could result in an economic recession.
Adam Posen, director of the Peterson Institute for International Economics, warned that cutting rates too quickly now increases the risk that the Federal Reserve will have to reverse policy and raise rates in a few months. Last year, several allies of Trump criticized that the Federal Reserve's rapid rate cuts were stimulating more persistent inflation risks.
Editor/Jeffy
