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Ask a Fool: Why Would the Federal Reserve Cut Interest Rates Now?

By Matthew Frankel, CFP® - Jul 26, 2019 at 12:00PM

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It's important to realize that the Federal Reserve has a dual mandate: to maximize employment and to maintain inflation at a desirable level.

Q: The Federal Reserve is expected to cut interest rates at its July meeting. Why is there such a push to cut rates while unemployment is near a record low and the stock market is at all-time highs?

The market is expecting an average of three 25-basis-point federal funds rate cuts by the end of 2019. At first glance, this may seem odd. After all, rate cuts generally coincide with some sort of economic weakness. But GDP growth is strong, the stock market just hit a fresh all-time high, and the unemployment rate in the U.S. is 3.7%, which is extremely low in a historical context.

Conversely, the last time the Fed began a rate-cut cycle (2007), unemployment had started to tick upwards and there were some major signs that the economy was beginning to deteriorate. For example, housing prices had already fallen significantly by the time the Fed made its first move.

To understand why a rate cut makes sense this time around, it's important to realize that the Fed has a dual mandate: to maximize employment and to maintain inflation at a desirable level.

Obviously, employment is maximized. However, inflation has been extremely low -- well below the Fed's 2% target rate. So unless there's inflation that needs to be controlled, there's a solid case to be made that it's in the economy's best interest to help sustain the expansion by cutting rates. In addition, global economic growth has started to slow, and the ongoing trade war is prompting an elevated level of caution among policymakers.

The bottom line is that the U.S. economy is solid, but the global economy isn't quite as strong as we'd like to see. And unless inflation starts to tick upward, it's tough to make an unassailable case against cutting rates to help the economy keep growing.

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