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Saudi shock presents a fresh unknown ahead of Fed rate meeting

Federal Reserve Chairman Jerome Powell has frequently relied on the mantra "control the controllable" as he has wrestled with President Donald Trump's erratic trade policies.

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Donna Borak
CNN — Federal Reserve Chairman Jerome Powell has frequently relied on the mantra "control the controllable" as he has wrestled with President Donald Trump's erratic trade policies.

But heading into this week's rate-setting meeting, the Fed is facing a different kind of threat: a potential oil crisis stemming from the weekend's attacks on Saudi facilities.

The Fed cut rates at its last gathering, in July, for the first time since the Great Recession, and is widely expected to cut again this week. But given rising global turmoil, the question almost immediately will be whether it will keep going as the year wears on to satisfy Powell's promise to keep the US economy humming.

"One of the biggest factors playing into our current economic outlook is uncertainty, along with a heightened level of this, higher oil prices may be just one more nail in the coffin for this current US expansion," Beth Ann Bovino, US chief economist at S&P Global Ratings, wrote in a research note on Monday. "As it is, we are already seeing businesses being reluctant to invest given the trade headwinds and this gives them more reason to hold off."

Powell backed a rate increase last December and had initially indicated he planned to continue tightening this year in the face of a thriving labor market and strong consumer demand. But that plan reversed as Trump's trade wars took a toll on the global economy, and Powell has signaled he's open to continuing to support the economy.

"We're going to continue to act as appropriate to sustain this expansion," Powell said on Sept. 6 during a question-and-answer session in Zurich.

The global economy is starting to show signs of strains as a result of the on-again, off-again trade war between the world's two largest economic superpowers, the United States and China. Several major countries have reported weak growth, with Germany's economy contracting slightly. China's economy continues to worsen as industrial production has weakened and retail has softened.

Resolution of the long-standing trade war has been elusive as officials on both sides have swung quickly from ratcheting tariffs higher to softening billions of dollars in economic penalties on goods, sending financial markets spinning.

The United States and China are expected to hold high-level negotiations in October, but no deal is guaranteed. And President Donald Trump has promised to impose additional tariffs by the end of the year unless the two sides reach an agreement.

Now the multiple drone attack on Saudi Arabia, which has significantly cut its crude output and rattled oil markets, could also complicate matters for the Fed.

"The attacks present yet another headwind for the global economy that is already buffeted by deteriorating manufacturing activity and elevated trade tensions," wrote Mark Haefele, global chief investment officer for UBS, in a note to clients. He said, however, that the short-term disruption to oil production was unlikely to trigger a global recession.

In recent months, Powell has said the US economy continues to remain in a "favorable" place, with moderate growth expected along with a strong labor market and inflation inching closer to the Fed's 2% target, the level it considers healthy for the US economy.

But he has also warned of "significant risks" facing the US economy, including slowing global growth and trade uncertainty, and has made explicit that there are "no recent precedents" to guide how policymakers should account for such trade policy uncertainty.

Powell has all but promised that the Fed would commit to lowering the federal funds rates -- which affects the costs of mortgages, credit cards and other borrowing -- to a range between 1.75% and 2.0%.

The challenge facing Fed officials is there are still signs the US economy is on solid ground, despite signals that consumer confidence has gotten shakier and business investment has waned along with a weakness in manufacturing.

The mixed economic picture has left Fed officials divided over whether the economy needs more support at this time to continue the expansion or whether it risks overheating the economy and causing inflation. Two members of the Fed's policy-setting committee -- Boston Fed President Eric Rosengren and Kansas City President Esther George -- voted against the decision to cut rates in July.

Investors will be looking for clues on what happens later this year, and whether the Fed may continue to ease amid a cloudy outlook and sustained economic uncertainty.

"The key for Powell will be to underscore the ongoing strength of the economy and the desire by the committee to hold their ammunition, which is limited, until they see worse economic data on the economy and/or a significant tightening of credit conditions," said Diane Swonk, chief economist at Grant Thornton, in a note. "They do not want to repeat the mistakes of last December when they looked asleep at the wheel."

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