"Yesterday the FOMC decided to reduce its short-term interest rate target by 25 bps. It was a move in the right direction (as I suggested in late May), but as today's market action demonstrated, it was an overly cautious move, particularly in light of escalating global trade tensions (i.e., Trump's tariffs, which today he threatened to ratchet higher). The US economy, as well as most major global economies, are facing headwinds, uncertainties, and slower growth, all of which have increased risk-aversion and the demand for money equivalents. A 25 bps cut to short-term interest rates helps offset the world's increased demand for money (by making money and money-equivalents less attractive), but only partially.
... A bigger cut would have been better, but this was not a fatal mistake. Why? Because the level of real interest rates remains relatively low, and liquidity conditions—thanks to the still-abundant supply of excess bank reserves and the low level of 2-yr swap spreads—are still quite healthy. It's a mistake to think that although it appears that today's monetary conditions are a bit tight (e.g, inverted yield curve, lower prices for risky assets), the economy is at risk. The Fed doesn't need to reduce interest rates in order to "bail out" the economy or to give it a shot of stimulus. The purpose of adjusting short-term interest rates lower under the current monetary regime of abundant excess reserves is not to "stimulate" the economy but rather to keep the supply of money in line with the demand for money. That, in turn, will keep financial markets healthy, avoid asset price bubbles and keep inflation low and relatively stable. Remember, monetary policy was never meant to stimulate or throttle growth. Growth is not created magically when the Fed lowers interest rates. Monetary policy is meant to keep the supply and demand for money in balance, and thus to deliver low and stable inflation, which in turn is conducive to growth."
(A non-fatal Fed mistake dated 08/01/2019 by Scott Grannis, Chief Economist from 1979-2007 at Western Asset Management.)
Read full article here: http://scottgrannis.blogspot.com/2019/08/a-non-fatal-fed-mistake.html