Why the Fed's data dependency 'breeds volatility': Economist

It's a critical week for monetary policy as several central banks around the globe are slated to release interest rate decisions. EY chief economist Greg Daco joins Catalysts to discuss how the Federal Reserve will approach its interest rate cut and how it may affect the market. "I think this week we're going to see the Fed ease monetary policy... We're likely to have the Bank of England on hold, and we'll have the Bank of Japan likely signaling or tightening monetary policy. So diverging directions there. I think, broadly speaking, in terms of the global economy, what we're seeing is an environment where the global economy is doing relatively OK, but we are seeing signs of slowdown in the US, which has been the main engine of global economic activity, the outperformer in 2023, the outperformer in early 2024, while Europe and the UK are struggling in terms of growth momentum," Daco tells Yahoo Finance. Daco expects the Fed to initiate a 25-basis-point cut as it kicks off its rate-easing cycle. He highlights the central bank's data dependency, and believes that moving forward, it will gradually cut rates. However, he explains, "Fed Chair Powell has shown openness to front-loading rate cuts, and if he manages to convince the rest of policymakers that a faster start to the easing cycle is necessary and useful for the economy, then that will be the trajectory." He argues that front-loading cuts "makes sense" as the Fed is behind the curve: "The Fed should have started easing monetary policy back in June, in July, perhaps. But now we're in September and we're late in the game." Yet, he notes that the Fed walks a delicate tightrope. "If you ease monetary policy by 25 basis points, it does little to nothing in terms of consumer rates, auto loan rates, mortgage rates, very little. But the risks are asymmetric. If the Fed does not ease monetary policy by as much as markets are anticipating, then you'll actually see a repricing of rates and you're going to see upward movement in terms of rates, and that could damage consumer spending activity, housing activity, business investment. That is the real risk right now," he explains. Daco adds that the Fed's data dependency "breeds volatility," which then causes "sudden repricing in markets that are deterring economic activity." He concludes, "That's the real risk right now, is that the Fed does not do what the markets are anticipating. And that's a lack of communication and a lack of robust framework on the part of the Fed that is leading to this."
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