Pledging 'appropriate' action on trade risk, Fed's Powell seen opening door to rate cut

By Howard Schneider and Ann Saphir

CHICAGO (Reuters) - U.S. Federal Reserve Chairman Jerome Powell said on Tuesday the central bank will "act as appropriate" in response to risks posed by a trade war, remarks that may open the door to the possibility of a rate cut.

"We do not know how or when these issues will be resolved," Powell said. "We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2% objective."

The brief statement opened a two-day session at the Chicago Federal Reserve intended to shore up the central bank's policies to prepare for the likely possibility that policymakers will eventually confront another recession and push rates back to zero, eliminating any room to cut further and thus exhausting a traditional policy tool.

The more immediate issue is how the Fed should respond to a trade war expanding on multiple fronts, after U.S. President Donald Trump slapped new 25% tariffs on $200 billion of Chinese imports and threatened new import taxes on Mexico unless immigration slows. The question of how to respond divides policymakers and markets.

Powell's remarks did not include a reference to the current Fed target interest rate as appropriate, or repeat the pledge to be "patient" before raising or lowering rates, both of which were standard talking points in recent Fed statements. His comments come a day after St. Louis Federal Reserve President James Bullard said in a speech on Monday that a rate cut may be needed "soon."

"We are likely seeing the beginning of coordinated Fed-speak to prep market participants for at least one rate cut this year," said John Doyle, vice president of dealing and trading at Tempus Inc in Washington.

Yields on 2-year Treasuries, which are particularly responsive to investors' forecasts about Fed policy, fell marginally when Powell spoke but eventually rebounded and were trading near their lowest levels in more than a year around 1.92%. The S&P 500 rose 1.5%.

Short-term interest rate futures imply the central bank will start cutting rates as soon as next month, as well as increasing fear that uncertainty about how the trade conflict will be resolved could push the United States and other economies into recession.

WORKING ON A NEW FRAMEWORK

Fed policymakers face conflicting signals. Government data shows that the U.S. economy has grown this year but markets point to significant risk of deterioration going forward.

Commerce Department data on Tuesday underscored that factory activity has weakened, with new orders for U.S.-made goods falling in April as shipments dropped by the most in two years.

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Asked on Tuesday to interpret market expectations of rate cuts, Chicago Federal Reserve President Charles Evans told CNBC, "at face value it suggests that the market sees something that I haven't yet seen in the national data."

He said he sees rates as having been appropriate but that uncertainty and tepid inflation presented risks worth monitoring. Over the long run, he said, policymakers may want to be more aggressive, using low rates to let inflation and economic momentum build.

That is among the considerations on the table at the Fed's summit in Chicago, a continuation of a series of meetings this year around the country involving academics, businesspeople and community leaders.

The Fed will consider how well it is prepared to meet the challenge of supporting the economy with rates at zero, including by buying bonds, as it did after the 2008 global financial crisis.

The Fed could also decide to welcome inflation temporarily a bit above its target - and keep rates lower for longer - in the hopes that such a strategy will make the Fed's goals for maximum employment and price stability more likely over time.