The Fed delivered a somewhat hawkish cut. The FOMC cut the benchmark rate 25 basis points for a second consecutive meeting, as three voters dissented with Bullard calling for a half point cut and George and Rosengren wanting to keep rates steady. The Dot plots show no more reductions through the 2020. Division is growing at the Fed as seven members are calling for another cut this year.
Regarding the recent strain on money-markets, the Fed acted swiftly in also cutting the interest on excess reserves (IOER) rate by 30 basis points. This was more of a plumbing issue for money markets and has no major impact on interest rates going forward.
Future easing expectations will depend on the data, and markets will likely continue to price in one or two more rate cuts before year end. Uncertainty to the outlook, muted inflation pressures, and global developments for the economic outlook drove today’s rate cut. With economic forecasts mainly unchanged, we should not be surprised the hesitation in the board’s commitment to a much lower trajectory for interest rates.
The Fed’s lack of conviction in signalling more rate cuts will probably be a policy mistake that is wasting the effectiveness of the first two rate cuts. The Fed seems set on waiting for a couple geopolitical risks to rattle the economy before committing to a full-pledged easing cycle.
Powell emphasized the weakness in the economy that has come from trade policy, this probably is as close off a jab to the President that we will see from Powell. The first question whether this is still a mid-cycle adjustment was answered with “if the economy weakens, more extensive cuts may be needed”. Powell reiterated they are not on a preset course, but with the downside risks likely to linger for quite some time, markets should remain confident more rate cuts are on the horizon.
Regarding the money market turmoil, Powell noted it has no economic significance, even though they may need to resume balance sheet growth sooner than expected.
What happens next?
It is unlikely that the significant risks to the outlook will magically improve before the year ends and so we should not be surprised if we see the Fed deliver another rate cut in October and possibly another one in December. Powell will need to cut interest rates more aggressively and consider QE since geopolitical risks are plentiful and global growth concerns are going nowhere. Powell could be waiting to see if the President will deliver an interim trade deal and if fiscal and monetary stimulus from the other major central banks will help provide some stability with the global economy. The Fed seems too optimistic that inflation will return to their target and despite their concerns with growth, they raised their GDP forecast. The doves only have one more rate cut expected and that won’t be enough to keep the record expansion going.
The bullish case for US equities did not get the medicine they wanted today, but with the global economy remaining weak, investors will prefer holding US equities. The Fed failed to stay ahead of the curve in delivering a clear steepening of the yield curve and we will likely see them pressured at the next meeting. Powell noted they will never use negative rates even in a time of crisis, suggesting QE would be the next hand they could play.
Oil prices drifted lower after a very bearish EIA report, also shrugging off the findings from the the Saudi Defense Ministry that confirmed what everyone already believed, that Iranian weapons were involved in the Saudi oil facilities attacks. US Secretary of State Pompeo signaled that the next step is to build a coalition with European and Gulf countries. With no immediate US-Saudi physical strikes on Iranian oil facilities or Revolutionary Guard assets, it seems the US course of action will be rather diplomatic and we could see crude continue to drift lower until we see a fresh escalation. The Fed was pretty much a nonevent for oil prices.
Gold sold off after the Fed failed to signal more rate cuts were a certainty. If the Fed wants to keep the record expansion going, they will need to deliver more cuts before the year is over and possibly consider QE. The risks to the outlook are overflowing and gold will likely see buyers emerge on this tentative selloff.
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