Powell Testimony to Be Watched Closely for Clues on Rates

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07/10/2019 | 09:47 am


By Nick Timiraos



With bond markets betting that the Federal Reserve is likely to cut interest rates at its July 30-31 meeting, Chairman Jerome Powell has a prime opportunity to either reset or ratify those expectations during two days of testimony on Capitol Hill starting Wednesday.



He will be making his first public remarks since President Trump and Chinese President Xi Jinping struck a trade cease-fire last month and the Labor Department released data Friday showing U.S. labor markets were solid through the first half of 2019.



Mr. Powell starts Wednesday with the release of his prepared testimony at 8:30 a.m. EDT, followed by his appearance before the House Financial Services Committee starting at 10 a.m. He returns Thursday to answer questions from the Senate Banking Committee, beginning at 10 a.m.



Meanwhile, the Fed will release minutes of the central bank's June 18-19 policy meeting on Wednesday at 2 p.m., offering new detail on how officials judged growing risks from trade uncertainty before last month's G-20 summit in Japan.



Here's a look at what to watch:



Economic Outlook



Fed officials in June signaled the possibility of rate cuts in the months ahead, citing three reasons for a weaker outlook: softer global growth, rising uncertainty from trade and other geopolitical developments and muted inflation. Notably, the first two of these have undercut hopes that low inflation at the start of the year might prove transitory.



The U.S. June employment report released Friday weakens the case for the Fed to deliver a larger, half-percentage-point rate cut this month. But the Fed doesn't place too much emphasis on any single data point, and it is global growth and worries about trade uncertainty--not potentially weaker labor markets--that were advanced as reasons for a rate cut last month.



Gauges of factory activity have shown the U.S. industrial sector is growing at a slower pace than last year but at better levels than in Europe and Asia.



Trade Winds



Several Fed officials had indicated before the Fed meeting that they wanted to see how the trade discussions between Messrs. Trump and Xi in Japan later in June would unfold before considering a rate cut. The two leaders agreed to resume negotiations, but didn't reach a major breakthrough that would substantially remove uncertainty for businesses.



The question now is whether continued uncertainty over U.S. trade policy is enough to justify a rate cut at a time when the U.S. economy remains healthy by several measures.



Time for Insurance?



The Fed usually cuts interest rates because bad things are happening. Sometimes, though, it cuts rates because of the risk of bad things has gone up--like taking out an insurance policy. That's what the Fed did in 1995 and 1998, avoiding recession both times.



The question for officials is whether this is one of those times. In projections released last month, around half of Fed officials penciled in rate cuts for the second half of the year. If they are now rethinking the case for a July rate cut. Mr. Powell's testimony gives him a chance to recalibrate market expectations. The minutes could provide further, albeit dated, details of the internal debate at the Fed's June policy meeting.



Inflation Puzzle



One big reason Fed officials are thinking about rate cuts is because inflation hasn't picked up as expected this year. Most of them have indicated they don't think a rate cut is warranted simply to boost inflation, but how Mr. Powell characterizes the inflation outlook is important nevertheless.



Core prices, which exclude volatile food and energy categories, have slowed this year, to 1.6% in May from 2% in December.



In early May, Mr. Powell pushed back against rising expectations in interest-rate futures markets about rate cuts by signaling strong conviction that the inflation slowdown would prove transitory. But by late June, with gathering headwinds threatening the growth picture, he said inflation softness might be more persistent than previously thought.



If officials are less confident inflation will return to their 2% target over time, this opens the door further to lowering their benchmark rate, which they have held in a range between 2.25% and 2.5% so far this year.



Political Pull



Mr. Powell has maintained a high profile on Capitol Hill, meeting with lawmakers individually and in groups. He recently addressed members of the Republican Study Committee, a group of conservative lawmakers, as well as House Democrats at their policy retreat in Leesburg, Va. Those meetings appear to have built a reservoir of goodwill for the Fed leader, which could be useful given Mr. Trump's vocal displeasure with Mr. Powell.



The hearing will give lawmakers an opportunity to publicly back Mr. Powell or echo Mr. Trump's criticism of the central bank leader.



Mr. Powell's reception in the Senate could be particularly notable because lawmakers there could take steps to prevent Mr. Trump from demoting Mr. Powell should the president attempt such a gambit. The law isn't clear on whether the White House has the authority to replace Mr. Powell.



Stressful Times



Mr. Powell can expect to get many questions on financial regulation. He could be asked, for example, to elaborate on his comments Tuesday that the Fed's annual stress tests--exams to determine whether big banks can survive an economic shock--need to change over time. "If the stress tests do not evolve, they risk becoming a compliance exercise, breeding complacency from both supervisors and banks," Mr. Powell said Tuesday to a conference at the Federal Reserve Bank of Boston.



The Fed recently made it easier for banks to pass the stress tests and is considering changes that would eliminate the chance that banks could fail part of the test. Those changes have sparked concerns from some Democrats, who say the Fed is making the exercise too easy for banks. For the second time ever this year, no firm failed the stress tests.



Write to Nick Timiraos at nick.timiraos@wsj.com





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