An Urban's Rural View

How We Could Have Both Lower Rates and a Stronger Dollar

Urban C Lehner
By  Urban C Lehner , Editor Emeritus
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The Federal Reserve has a tricky situation on what to do about interest rates. (DTN file photo)

Low interest rates are popular in the ag world, which like most worlds has more borrowers than lenders. When the Federal Reserve lowers interest rates, as it did the other day, farmers and ranchers are grateful.

Yet in many ways this cut was the most problematic move in Jerome Powell's 18-month tenure as Fed chair. Here are five ways the move can be questioned:

1. On one hand, it was far from clear a cut was needed. The most recent economic data had been better than expected. Powell himself called the economic outlook "favorable." The cut, he said, was "insurance" to maintain the economy's strength. There was dissension within the ranks on the advisability of that insurance. Two dissenting Fed policymakers voted to keep rates unchanged.

2. If it was insurance, the markets, which have a much more pessimistic view of the economy, felt the Fed didn't buy a big enough policy. They were hoping for a half point cut or at least hints that this was just the first of many cuts. In both hopes they were disappointed, and as a result they tanked.

3. The cut probably won't help the economy much. Interest rates aren't what's inhibiting business investment; they're already low. Rather, businesses are holding back on capital projects owing to trade-war uncertainties.

4. It threatens confidence in the Fed's political independence by making it look like the central bank caved to threats from President Donald Trump, who has been unceasing in his demands for cuts and harsh in his criticism when they weren't forthcoming.

5. It encourages the president to take big trade-war risks. Though the president grouses that the Fed isn't helping him, it actually is. Trump's escalations threaten to tank the economy; the interest-rate cut assures him that the Fed will step in to prop the economy up.

Why, if the move is so open to question, did the Fed make it? Consider the central bank's tricky situation:

Because interest rates never returned to anything like normal after the 2008 financial crisis, the Fed doesn't have the luxury of waiting for a recession before cutting; the difference between a 2.5% Federal funds rate and zero isn't big enough to resuscitate a flagging economy. Instead the Fed must try to prevent a recession from happening. That's what Powell meant by "insurance."

The biggest threats to the economy are those trade-war uncertainties. In justifying the cut despite the favorable outlook, Powell cited "weak global growth and trade tensions." (https://www.nytimes.com/…)Since the cut, other Fed officials have indicated that "trade headwinds" are making their assessment of the economy unusually complicated. (https://www.wsj.com/…)

The other justification for the cut is the continued cutting by central banks in Europe, Japan and elsewhere. Although the Fed doesn't target the dollar, the effect of being out of line with overseas central banks was to strengthen the greenback. By getting in line, the Fed slowed this artificial strengthening.

For that, American exporters, farmers and ranchers included, can be thankful. Except for one thing: Trump's latest escalation -- tariffs on all Chinese products -- has so added to financial uncertainty that foreigners are moving into the dollar as a safe haven. Low rates ought to weaken the dollar but their effect is overwhelmed by fear of recession and even financial crisis, which makes foreigners seek refuge in the dollar. The president wants a weaker dollar but his own behavior is making it stronger.

Where does the Fed go from here? Powell indicated that this move wasn't the first in a long series of cuts. It was a mid-course correction. That was probably his intention at the time the vote was taken, but the subsequent escalation of the trade war could weaken the economy further and force the Fed's hand.

There's no good news here for the economy, then. There may be good news for borrowers, as the worse the trade war gets, the greater the chance of further interest-rate cuts. But we could also end up with what seems like a contradiction: lower rates and a stronger dollar. As much as the president wants to blame the Fed for everything, it's hard to fault the central bank for this. It's being pulled in a direction it doesn't want to go by the undertow from Trump's trade war.

Urban C. Lehner can be reached at urbanize@gmail.com

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