Fixed Income

Did the Fed just go Minority Report?

The Federal Reserve recently cut the Fed Funds rate in an effort to pre-empt negative outcomes
September 2019

BMO US Fixed Income Team

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Risk Disclaimer

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Changes in rates of exchange may reduce the value of your investment.

Changes in interest rates can affect the value of fixed interest holdings and may adversely affect the value of your investment.

On 31 July 2019 the US Federal Reserve cut the Fed Funds rate, marking not only a shift in monetary policy in today’s environment, but also a paradigm shift in the bank’s approach. Policy makers explained their goal as being to “extend expansion” and recently described their approach as an “ounce of prevention is worth a pound of cure”.

Their view expresses that, in an already low rate environment, the need to act early becomes more acute. In this approach, easing policy in advance of negative data is executed as an “insurance cut”.

The desire to pre-empt negative outcomes is logical from those in positions of power, but we are reminded of the dangers of such an approach by the 2002 dystopian drama, Minority Report. In that film, the PreCrime police unit eliminates all murders by anticipating these crimes and arresting individuals before they commit them. Of course, even in the future, the ability to predict is imperfect and the movie centres on the limits of such predictions and the Pandora’s box opened by attempting to foresee and change the future.

We believe the Fed is taking a risk – one we hope works – in shifting from reactive to pre-emptive monetary policy. It was not that long ago that the Fed was more forthright about the uncertainty inherent in economic forecasting as Chairman Powell used the analogy of walking into a dark room and slowing down to avoid furniture as an analogy for the Fed’s situation. Today, they seem more certain that they know the future and aim to alter it. We hope this approach works as the consequences for failure seem more pronounced than the end of a single economic expansion.

Risk Disclaimer

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Changes in rates of exchange may reduce the value of your investment.

Changes in interest rates can affect the value of fixed interest holdings and may adversely affect the value of your investment.

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