By Howard Schneider and Trevor Hunnicutt
WASHINGTON (Reuters) - Federal Reserve Chairman Jerome Powell on Wednesday set the stage for the first U.S. interest rate cut in a decade later this month, pledging to 'act as appropriate' to defend an economic expansion threatened by trade disputes and a global slowdown.
In testimony to a congressional committee, Powell pointed to "broad" global weakness that was clouding the U.S. economic outlook amid uncertainty about the fallout from the Trump administration's trade conflict with China and other nations.
Though the U.S. government reported strong job growth for June, other major economies' "data have continued to disappoint. That is very broad across Europe and around Asia, and that continues to weigh," the head of the U.S. central bank said.
"Manufacturing, trade and investment are weak all around the world ... We have agreed to begin (trade) discussions again with China, and that is a constructive step. It doesn't remove the uncertainty."
To the suggestion that the current low U.S. unemployment rate could lead to a breakout of inflation, Powell noted that the overall pace of price increases remains "muted" and wage gains remain modest, signs the Fed could reduce rates without risk of an overheating economy.
"We don't have any evidence for calling this a hot labor market," Powell told the U.S. House of Representatives Financial Services Committee. "To call something hot we need to see some heat."
The hearing, part of the Fed chief's semi-annual testimony on monetary policy to Congress, took place against the backdrop of U.S. President Donald Trump's frequent criticism of the Fed and the White House's demands that the central bank lower rates.
Powell, chosen by Trump to run the Fed but now out of his good graces, has worked hard to build relations among lawmakers, and even on a Democratic-controlled committee won plaudits and encouragement to stay on the job.
Asked by Representative Maxine Waters, who chairs the committee, if he would "pack up and leave" if the president demanded it, Powell replied with a curt "no ma'am ... The law clearly gives me a four-year term and I fully intend to serve it."
In prepared remarks released before the hearing, Powell contrasted the Fed's "baseline outlook" of continued U.S. growth against a considerable set of risks - including persistently weak inflation, a slowdown in other major economies, and a downturn in business investment driven by trade risks.
Fed officials at their June policy meeting signaled those concerns might warrant lower rates, and "since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. outlook," Powell said.
"Apparent progress on trade turned to greater uncertainty, and our contacts in business and agriculture reported heightened concerns over trade developments," Powell said, noting that business investment, an important component of economic growth, "seems to have slowed notably" in recent months.
"Powell is setting it up, certainly for a July rate cut," said Jack Ablin, chief investment officer at Cresset Capital Management in Chicago. "To me, it all depends on where you look in the economy. But over the last decade, the Federal Reserve has been banging the inflation beehive with a baseball bat and the bees haven't come out, so they figure keep trying this until something happens."
U.S. stocks were trading higher, with the benchmark S&P 500 (SPX) index briefly crossing the 3,000-point mark for the first time. The U.S. dollar (DXY) fell against a basket of other currencies.
Government bond yields dipped, with two-year Treasuries (US2YT=RR) falling below 1.87%, from around 1.93% earlier on Wednesday. Meanwhile, U.S. interest rate futures appeared to price in greater odds of a 50-basis-point rate cut this month.
TARIFF THREATS
The Fed, which hiked rates four times last year, has kept its current benchmark overnight interest rate in a range of between 2.25% and 2.50% since December.
Since a series of Trump trade-related tweets in late May, both investors and the Fed have begun shifting their stance, with markets now expecting a cut of at least a quarter of a percentage point when the Fed's rate-setting committee releases its next policy statement on July 31.
The U.S. economy did not change much in the days that followed Trump's May 30 comments on Twitter threatening to impose tariffs on Mexico unless the country met his demands for tougher controls on immigrants crossing its northern border.
But Trump's statements spooked financial markets so decisively, and the threats to the global economy became so palpable, that a rate cut of at least 25 basis points now appears a near certainty, with a 50-basis-point cut also considered possible as extra protection.
The Fed is due to release the minutes from its last policy meeting at 2 p.m. EDT (1800 GMT) on Wednesday. The minutes should show the extent to which the thinking at the central bank shifted in the days following Trump's Mexico tariff threat, and how the discussion was shaped by other concerns including weak inflation.
Earlier rounds of U.S. tariffs on trading partners including China had been dismissed by the Fed as of little macroeconomic importance, with central bankers in early May still anticipating its policy rate would remain unchanged for the rest of the year.
By contrast, the higher tariffs announced against China in early May, a rising sense the world's two largest economies might not be able to make a deal, and the tariff threat against Mexico added to a growing feeling that protectionism and higher tariffs were here to stay - at a cost to investment and growth.
'NO IMMEDIATE NEED'
The case for lowering borrowing costs isn't fully decided.
Reducing rates at this point would be similar to the Fed's efforts in the mid-1990s to nurse along a lengthy recovery rather than respond to a looming downturn, and "there's no immediate need to move," Philadelphia Fed President Patrick Harker said on Tuesday.
But Trump's tweets about Mexico had a particularly unsettling impact, touching off enough volatility and doubt about the future that it pushed the Fed towards the very rate cuts Trump has demanded for other reasons.
At the Fed's last policy meeting in mid-June, eight of the 17 policymakers saw the need for at least one rate cut by year's end, and Powell told reporters afterwards many others were leaning in that direction. The minutes may show how strong that sentiment has become.
In the Fed's monetary policy report issued last week ahead of Powell's testimony, the trade war received its own analysis, a sign of the attention it is getting within the central bank.
Powell will testify again on Thursday before the Senate Banking Committee.
(For a graphic on 'U.S. 5-year, 5-year forward breakeven inflation rate' click https://tmsnrt.rs/2PdzVzO)
(For a graphic on 'Powell is no stranger on Capitol Hill' click https://tmsnrt.rs/2JAUmkH)