us fomc rate decision reaction
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A CUT IS COMING BUT MARKETS MAY BE OVER DOING THE FED'S ENTHUSIASM FOR LOWER RATES

-          FOMC Signals Willingness To Cut Rates This Year, As Language Is Modified

-          Markets Fully Pricing A 25bps Cut In July, Another 25bps by year-ends

-          G20 Talks Between Trump and Xi Critical To Degree of Accommodation

 

By the end of its June rate decision and press conference the Federal Open Market Committee (FOMC) of the US Federal Reserve, markets were left in no doubt at rate cut of at least 25bps is imminent when the board next meet in July.

 

As expected, the FOMC kept its Fed funds target in the range of 2.25pct to 2.50pct. The voting pattern was 9-1 in favour of keeping rates on hold, perma-dove James Bullard, President of St. Louis Fed dissented in favour of a quarter point cut.

 

The general assumption ahead of the announcement was that the Fed would do little to dampen expectations of an impending cut, and in this regard, it did not disappoint. Despite not signalling outright that it would cut in July, markets have now fully priced in a 25bps cut at the July FOMC meeting.

IS IT ONE AND DONE?

Despite the markets running away with an imminent rate cutting cycle, there is reason for caution. Deliberate changes in the opening statement helped cement market sentiment towards a succession of cuts. The FOMC statement acknowledged the strong labour market and a pick-up in household spending. But, in a modification to the previous statement, the central bank removed reference to ‘solid economic activity’ and instead pointed to activity moving at a ‘moderate’ rate.

 

However, in a sign that a series of cuts was not a forgone conclusion, Fed Chair Jerome Powell warned that is was important to not ‘Overreact’ to single data point, when asked a question during the succeeding press conference. “Risk of waiting ‘too long’ on policy changes is not prominent, the Fed tries to avoid acting prematurely.”

 

Powell’s caution aside, there was enough in the messaging for markets to believe a cut is around the corner and this was clearly the intention of the Fed. To add to the fervour, there is a sizeable market view that when the cut comes, we could even see a unconventional 50bps of cuts, in one go.

 

TS Lombard’s Chief Economist, Steven Blitz, “We believe St Louis Fed President Bullard’s dissent was made public to underscore that, barring a dramatic turnaround in the data, the next move is a cut - perhaps even a 50bp reduction.

 

“The Fed is not in the business of validating market pricing except when they are both heading in the same direction, and that is what the central bank did yesterday.”

DOT PLOT EASING

One of the more main pillars of communication from the Fed, the ‘Dot Plot‘ chart reflected a change in Fed member’s central view of the rate path. New forecasts showed eight governors saw rates unchanged through 2019, with eight looking for a quarter point cut, with one expecting a hike. The 2020 dot was dropped to 2.1pct from 2.6pct (reflecting 30 bp of easing from here) and the long-run dot was lowered to 2.50pct from 2.8pct.

 

Yet, even using this method of communication there is a need to add a little perspective, “If you are too focused on a few dots, you may miss the larger picture,” Federal Reserve Chairman Jerome Powell told audience members at a Stanford University economics summit on March 8, referring to the forecast’s granular view of policy.

Source: Federal Reserve Monetary Policy Files
Source: Federal Reserve Monetary Policy Files
THE CASE FOR A CUT IS A VALID ONE

Regardless of the possibly over eager reaction of the market to the June announcement, there are genuine areas of concern for the Fed and Powell acknowledged this during press conference. “In light of increased uncertainties and muted inflation pressures, we now emphasise that the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion,” vowed Powell.

 

Trade continues to be a an ‘unknown known’, and the re-emergence of tensions with China is seen as a crosscurrent for the US economy. The Fed view is that the global growth outlook is still regarded as disappointing.

 

Domestically, survey evidence has suggested business fixed investment has been soft., with market-based measures of inflation compensation having declined of late.

 

Yet, potential action is muddied by the political backdrop. It would be reasonable to assume Powell and the board are at the very least irritated by White House comments regarding its monetary policy decision making process. Powell is unlikely to appreciate any perception he has been pressured by President Trump into cutting rates.

 

Another possible reason for inaction this month is the upcoming G20.  China and the US have scheduled a sideline meeting at the G20, in late June. This meeting could be pivotal and determine the direction of trade talks moving forward.

MARKET REACTION

Initial reaction saw US 10-year Treasury yields spike lower, to fresh 3-year lows, with further losses into the Asia session and the curve steeper on the day at 21 bp. The potential new easing cycle was enough for global equity markets to rally, and US indices traded back at record highs. The bullish tone spilled over into Asian indices, most markets up by around 0.5pct. The exception being China indices which outperformed, rising some 3pct. In the FX markets, the USD traded weaker, with EURUSD above 1.1250, USDJPY below 108 and cable just under 1.27.

ECONOMISTS' THOUGHTS

Barclays’ Michael Gapen -- We retain our outlook for Fed policy. Following the outcome of the June FOMC meeting, we retain our expectation for 75bp in policy rate cuts this year, beginning with a 50bp rate cut at the July FOMC meeting. The main risk to our forecast is a more favourable outcome to G20 trade negotiations that, combined with favourable incoming data, could lead the committee to cut rates by only 25bp in July and 50bp this year.

 

TS Lombard’s Chief Economist, Steven Blitz -- Why wait for confirmation of lower inflation when you have already cut your inflation forecast and the aim is to show the Fed is not “weak on inflation” but determined to reach its 2% target? Moreover, waiting makes little sense knowing that there is a lag of 12-18 months before monetary policy impacts real activity and that the one-year anniversary of last year’s final two rate hikes is looming just as inflation is weakening. The unspoken answer is politics, and this is no surprise. The timing of next week’s G20 summit in Japan is one reason — although, to be fair, this is partially an economic reason as well, given how the global slowdown is helping to drive the Fed’s policy shift. President Trump’s blatant bullying of Powell to get him to cut is another.

 

Michael Gregory, CFA, Deputy Chief Economist -- The Fed is waiting for more information. It’ll get some major items before the next meeting (July 30-31). There’s the June 28-29 G20 confab and the Trump/Xi meeting, the tone of which will partly determine whether we get U.S. tariffs on remaining Chinese imports. The Fed will also get a clearer picture of Q2 growth with advance estimates to be released July 26, including core PCE inflation figures through June. Given our pessimism about a U.S./China trade deal getting done, and our judgement that the odds favour some expansion of tariffs on Chinese goods, we’ve been calling for a rate cut next month.

 

Pantheon Macroeconomics Chief Economist, Ian Shepherdson -- In short, this statement, the forecasts, and the dotplot do not guarantee any easing this year, still less the two cuts markets want to see, at least.  If a trade deal is done and growth is robust - this is our base case - the Fed will not want to ease at all. Policymakers presumably would prefer markets to work this out for themselves, rather than the Fed having to stand up and point it out. But everything is contingent on trade; developments over the next few weeks hopefully will clarify the picture, one way or the other.


 --- Harry Daniels

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