Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):
The Federal Open Market Committee (FOMC) cut the Fed Funds rate target range by 25 bps to 1.75% ‐ 2.00%. The post-announcement reaction was mixed with risk assets underperforming and the Treasury yield curve flattening. While Chair Powell communicated a willingness to adjust policy to sustain the expansion, he was hesitant to commit to the additional rate cuts that financial markets are pricing for 2020. In addition, he did not address a permanent solution for the concerns within the short-term funding market. He continues to view recent adjustments in the context of insurance against downside risks rather than the start of a longer easing cycle, although he avoided explicitly characterizing it as a “mid-cycle adjustment”.
The September FOMC statement maintained most of the language used in July including the comment that the Fed will act as necessary in order to sustain the expansion but also noted that trade uncertainty is broadening to other sectors, specifically exports. While the Committee still expects a strong labor market and 2% inflation as the most likely outcomes, the statement maintained mentions of uncertainties in conjunction with muted inflation pressures as reasons to closely monitor the data.
The Summary of Economic Projections reflected two camps: seven participants are looking for an additional cut in 2019 while five set their projections 25bps above the current rate.
Formally, there were three dissenters at the meeting, Esther George and Eric Rosengren both preferring to keep interest rates unchanged while James Bullard preferred to cut rates by 50 bps.
The interest on excess reserves and reverse repo rate were also adjusted down by 30 bps each to help keep the Fed funds rate trading in the new range.
We can break the statement into two parts:
- Economic Assessment – The Committee modestly adjusted its current assessment. While household spending was solid, business investment remained soft and exports weakened. On inflation, the Committee characterizes inflation expectations as remaining low according to market-based measures. Realized inflation remains low with both headline and core inflation below the 2% target.
- Outlook – The Committee maintained the statement that they will “continue to monitor” incoming information given elevated uncertainty and muted inflation pressure. While the Committee continues to expect the most likely outcome to be sustained growth accompanied by a strong labor market and inflation matching their objective, they maintained language to reinforce the fact that the Committee is willing to take action and adjust policy in order to sustain the expansion.
Summary of Economic Projections
- Within the projections, growth and inflation forecasts were little changed. Core PCE inflation is not projected to rise to the 2% target till 2021.
- The median dot for 2019 shows the Fed Funds rate at 1.875% which matches the current rate following the September adjustment. The 2019 distribution is more bifurcated. There is a group within the Committee forecasting an additional rate cut in 2019 while there is another group with their policy rate forecast set above the current Fed Funds rate.
- Beyond 2019, the 2020 median dot moved 25 bps lower to 1.875 bps to match the current Fed Funds rate versus the June projection to 2.125%. The median dot in 2021 also moved lower versus the September forecast to 2.125% indicating one rate hike in 2021. The 2022 dot was introduced for the first time at 2.375% indicating an additional hike in the out years moving us closer to the long run median dot which was unchanged at 2.5%.
Chair’s Press Conference
Chair Powell spent much of his time explaining the Committee’s rationale for easing monetary policy for a second time this year while also indicating that their base case of low unemployment and stable inflation remains unchanged. He continued to highlight the growing gap between the weak global growth backdrop and softening US manufacturing sector in contrast to the continued strength in the US labor market.
In general, Chair Powell showed little immediate concern for the US economic outlook. He dismissed the slowdown in payrolls growth as expected and indicated the consumer is still very strong. On the inflation side, Chair Powell continued to express the risk that inflation expectations could slide lower but also noted that realized inflation was rising closer to their target more recently.
Rather than focus on the number of additional rate cuts he expected, Chair Powell repeated the Committee’s desire to “sustain the expansion” and that they will adjust policy as appropriate to do so. While he mentioned it could be in theory better to be “proactive” as an approach to monetary policy, in reality the Committee was taking their decisions “meeting by meeting” and policy was not on a “pre-set” course.
Many reporters asked questions focused on the repo funding market and the rise in short-term lending rates experienced by financial markets this week. In general, Chair Powell dismissed these concerns as having little implication for the broader economy. He communicated that for now, they would address these funding strains using temporary open market operations such as the overnight repo operations the NY Fed has now conducted for the past two days rather than announcing more permanent solutions to address the issue.
- We expect the Fed to cut policy rates two additional times in 2019 in order to address the downside risks to US growth, rising trade tensions and slowing business investment. With additional policy easing expected, Treasury yields across the curve will move lower as we close out the year.
- In today’s meeting, the Committee signaled their willingness to match the market’s expectations for rate cuts in order to keep financial conditions easy in the very short term. Over the medium term, they appear to be uncomfortable committing to a more aggressive easing of policy until there are clearer signs of weakening in the service sector and labor markets.
- The case for the Fed to continue to ease policy further is bolstered by low inflation and inflation expectations that remains below the Fed’s 2% target.
- The Fed is conducting a monetary policy review this year, in which they appear to be considering a modification to their inflation strategy in order to better achieve their inflation objective and avoid an unwanted downward drift in inflation expectations. Although a formal change is not imminent in the next few months, the trend of Fed speakers indicates the Committee is leaning towards some type of change that would encourage more inflation and could result in an average inflation target – which would incorporate past misses in inflation more explicitly. The result would mean easier policy for longer unless realized inflation rises more materially and could also mean additional rate cuts would be justified if inflation is weakening along with softening growth prospects.
Opinions, estimates, forecasts, projections and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. There can be no guarantee they will be met.