RPT-COLUMN-Conditions as loose as 2021 call into question more Fed cuts: Mike Dolan

By Mike Dolan

LONDON, July 24 (Reuters) - Amid all the mounting political pressure on the Federal Reserve to resume cutting interest rates, Chair Jay Powell is already overseeing the loosest financial conditions in the U.S. economy since before the central bank started hiking early in 2022.

To be sure, the complicated debate about the Fed's next move includes many opinions on a host of issues, including the potential inflationary effect of tariffs, the impact of immigration curbs on wages and job growth, high mortgage rates and lofty government funding costs.

The Fed's own modeling suggests that its policy is still moderately "restrictive" relative to where long-run neutral rates should be, mainly because inflation is still above target, the jobless rate is near historic lows and real economic growth has rebounded from a first-quarter hiccup.

However, the Chicago Fed's national index of broad financial conditions in the U.S. economy has fallen to its lowest level in more than three years, suggesting financing in the economy is more than ample.

The index captures a blizzard of financial inputs from short- and long-term interest rates to equity and energy prices.

The likely culprits for its decline include the rebound in U.S. stock markets from April lows back to record highs, the dollar's plunge this year and crude oil prices running at a year-on-year decline of some 20% since April.

There are many other indexes of financial conditions, of course, but they mostly tell a similar story. Goldman Sachs' U.S. equivalent is back down to where it was late last year, just a whisker from its three-year low.

One takeaway from these readings is that despite trade uncertainty and sticky borrowing costs, the overall economy is doing just fine and has enough financial oxygen to continue chugging along, perhaps even a bit too much given the above-target inflation rate.

And, if so, the Fed's current policy stance may be less restrictive than it appears on the surface, even before slashing rates further as demanded daily by President Donald Trump.

AS LOOSE AS EARLY 2022

In the U.S. economy today, both jobs and cash holdings appear plentiful. Business confidence has also rebounded after taking a sharp knock from the April tariff shock, a trend that July business surveys are likely to confirm this Thursday.

U.S. household deposits clocked in at $4.46 trillion at the end of the first quarter, less than $100 billion below the record peak of 2022. Cash-like money market fund assets, meanwhile, hit a record of $7.1 trillion earlier this month.

And U.S. stocks still continue to push further into record-high territory, with retail investors seen as key drivers of demand. Even frothier parts of the U.S. market, such as "meme stocks" and crypto tokens, are back in vogue.

Resuming rate cuts at this juncture could add significant fuel to that rekindled fire, an argument for using caution in doing so.

For all the focus on borrowing costs and credit as key metrics of spending, the "wealth effect" of rising stocks is powerful. Some estimates show a "wealth effect" from investments added as much as 1% to U.S. consumer spending last year. This was driven by the more than 20% of households with direct stock ownership and the over 50% with retirement accounts.

Trump's argument that Fed rates are too high and should be cut by more than three percentage points to 1% hinges variously on the idea that high mortgage rates are preventing people from buying houses and that U.S. government borrowing costs are too high.

Indeed, the likely hefty schedule of Treasury bill sales expected over the coming year may be the key reason for the White House's urgency.

So regardless of what political pressure is brought to bear, and even if tariffs don't prove inflationary, the Fed may struggle to justify steep rate cuts in this environment.

The opinions expressed here are those of the author, a columnist for Reuters

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