Cutting from strength, or from fear?

With headline consumer price inflation dropping to 2.5 per cent in August and the Federal Reserve on the cusp of easing policy, financial commentators are debating the central bank’s fundamental motivation: is Jerome Powell cutting rates from a position of economic strength, or from growing institutional fear?

The Logic of Pre-Emptive Insurance

Cutting rates when inflation has receded to target while GDP is expanding at two per cent is the textbook definition of successful pre-emptive easing. It allows policy to normalize before monetary restriction causes unnecessary damage to employment. However, if the Fed is easing because it recognises that the labor market is on the verge of non-linear deterioration, the rate-cutting cycle will be far more aggressive than markets currently anticipate.

Whether the Federal Reserve is cutting interest rates from economic strength or creeping institutional fear will determine whether risk assets experience a benign melt-up or a violent recessionary repricing.