Wrapping up the mid-cycle adjustment
Dr. David P. Kelly
The Federal Reserve (Fed) cut the federal funds target rate by 25 basis points for the third consecutive time to a range of 1.50%–1.75%, again citing global developments and muted inflation pressures. The action was fairly decisive, with eight members voting to cut rates and two members voting to maintain the target range. The Federal Open Market Committee (FOMC) also lowered the rates of interest paid on both required and excess reserves by 25 basis points.
Although a cut was widely anticipated at this meeting, markets were keen to understand the future path of this “mid-cycle adjustment.” The language in the FOMC statement was balanced, maintaining the phrase “uncertainties about this outlook remain,” but removing that it “will act as appropriate to sustain the expansion.” However, in the press conference, Fed Chairman Jerome Powell clarified that the FOMC feels that the current stance of monetary policy is appropriate, and that risks to the outlook have moved in a positive direction. He noted that since monetary policy acts on a lag, the Committee will wait to see the full impacts of the three cuts. Therefore, this is likely the conclusion of the mid-cycle adjustment, reducing the possibility of a December rate cut unless there is a material deterioration in current conditions.
Chair Powell did not provide much additional information about the announced balance sheet expansion, in which the Fed purchased USD 60billion of Treasury bills in October, and will adjust that amount as necessary each month through 2Q20. Powell reiterated that the purpose of this balance sheet expansion is not quantitative easing, but a purely technical adjustment to ensure that the supply of reserves remains ample, in light of recent liquidity issues in the funding markets.
The market reaction was relatively benign, with stocks slightly higher and yields slightly lower, indicating that the statement and comments may have provided adequate clarity. With the Fed likely on pause for the rest of 2019, there is a low probability of cuts in 2020, but also a low likelihood of hikes, given declining inflation expectations. Nevertheless, the Fed remains data dependent, and while the Fed assesses that 2019’s principle risks of trade uncertainty and global weakness may be fading, there are more domestically oriented risks in 2020, as the pace of payroll gains continues to slow.