Federal Reserve chairman Jerome Powell, speaking in Denver on Tuesday, said the nation’s central bank was ready to boost its balance sheet again to address a cash crunch in the financial system.
But he was mum on whether the Fed would cut interest rates for the third time this year at its meeting on Oct. 29-30, saying the decision remained “data-dependent.”
“There is no reason the expansion can’t continue,” Powell told an audience filled with people who make a living trying to figure out what the economy and the Fed will do next.
He described the economic outlook as “favorable,” but added that trade tensions and a global slowdown provided risks to that outlook.
Powell emphasized that the purchase program that will be announced later this month was for “reserve management” and not a return to the large-scale asset purchases the Fed made between 2008 and 2015 to shore up the financial system.
Those three rounds of purchases were known as quantitative easing, or QE, but over time they provided diminishing returns.
“This is not quantitative easing. In no sense is this quantitative easing,” Powell told members of the National Association for Business Economics, which is holding its annual meeting in Denver.
But it wasn’t long after that statement that some market watchers started calling it that.
“Fed chair Powell announces QE4 … but don’t call it QE4,” responded ZeroHedge author Tyler Durden in a blog post.
Before the 2008 crisis, the Fed’s balance sheet stood at under $900 million. To provide banks with liquidity, keep rates low and give the economy a lift, the Fed boosted its balance sheet to $4.5 trillion.
As the recovery found more solid footing, the Fed began raising interest rates and reduced its holdings to around $3.7 trillion. But it has reversed course this year, cutting rates twice. And now its balance sheet is growing again.
Since Sept. 16, the New York Fed has had to throw a lifeline to the overnight lending markets, where lenders have become increasingly unwilling to swap the cash they have for the collateral of government securities, which are pouring onto the market as federal deficits rise.
The short-term cash loans are vital to keeping the financial system running smoothly, and things are jamming up in a way they haven’t since 2008. Overnight rates, which had been in the 2% range, shot up to 10% last month as borrowers became desperate for cash.
That threatened to blow a hole through the ceiling of the 1.75% to 2% range the Fed had set for the federal funds rate in September. To avoid losing control of short-term rates, the central bank stepped in and injected billions of cash into the markets.
But the cash crunch has persisted, which will necessitate a more permanent solution.
Growth in the U.S. is slowing, Powell acknowledged, but he added the economy may just be taking a breather, something lower rates would help with.
When the Fed cut rates in 1995 and again in 1998, those moves helped prolong the economic expansion and stave off a recession.
Powell described vulnerabilities to the financial system as “moderate” and said household finances are in good shape.
If the economy is as strong as the Fed says it is, then why cut rates, asked Christina Romer, professor of economics at the University of California Berkley during a NABE panel on Monday.
“Oh my God, what do they know that I don’t know,” said Romer of one reaction she had when the Fed began cutting rates in an economy where the unemployment rate hit a 50-year low last month.
But other numbers, such as industrial production, are weakening. While low rates could encourage more speculation, she said she can see the argument for making pre-emptive moves to avoid a recession.
Effectively, the Fed is buying insurance, she said.
