Despite the markets’ urgings, the Fed stays on hold…for now
The Federal Reserve (Fed) declined to reduce its benchmark interest rate at its June meeting, but it seemed to open the door to such a move at a future meeting. The Fed’s accompanying statement noted that U.S. economic growth had slowed to “moderate” from “solid” since its last meeting. However, its updated economic projections made no downgrades to its outlook for GDP growth or the labor market. The so-called “dot plot,” however, shows that a significant number of Federal Open Market Committee (FOMC) members—eight, to be precise—now believe at least one rate cut will be appropriate later this year.
Overall, the Fed sent a dovish signal to markets by repeatedly pointing out increased “uncertainties” in the outlook. While it did not specify the precise source of the uncertainty, it’s safe to assume that trade risks and slowing global growth are central to the Fed’s ongoing concerns. The Fed removed a reference to “patience” in its statement, indicating it stands ready to cut rates if conditions warrant.
What changed since May 1?
What hasn’t changed since May 1? Five days after the last Fed meeting, President Trump announced that trade talks between the U.S. and China had broken down, triggering higher tariff rates on approximately half of U.S. imports from China. China retaliated with new trade restrictions of its own. While the direct economic effects of the higher tariffs should be relatively minor, the impact on financial markets was severe and immediate: interest rates and equity markets plunged together in May.
Tariffs aside, after showing evidence of a rebound in the first quarter, global economic growth appears to have softened once again. In the U.S. specifically, the pace of hiring has slowed, capped off by a particularly weak employment report for May.
The net result has been a dramatic repricing of market expectations for the Fed’s interest rate policy over the next six months. According to market pricing, the probability of a rate cut by the end of the year has gone from a 50-50 proposition after the last FOMC meeting to a virtual certainty coming into the June meeting. Following the meeting, the odds increased further, especially those for three or more cuts. Hope for a Fed rescue has helped equity market indexes climb back near all-time highs, even as longer-term interest rates have continued to fall.
An economy with 3.6% unemployment would not seem to be in need of easier monetary policy. But the loss of confidence among businesses since the start of the trade war last year has already led to lower growth in private investment and could eventually cause a slowdown in hiring.
The Fed came into this week’s meeting with a choice: push back against markets clamoring for lower rates or adopt a more dovish posture to instill confidence among businesses and investors. It attempted to have it both ways by both signaling that it hears and shares the markets’ concerns while declining to cut rates preemptively and potentially trigger a further panic.
The market reaction shows that the Fed may have succeeded in its communication efforts. Stocks and bonds rallied together and the U.S. dollar weakened, but only mildly, as the Fed seemed to satisfy those who feared it would ignore growing policy risks.
What will the Fed do next?
Next month, the current economic expansion will become the longest in U.S. history. Ten years removed from the last recession, long-term interest rates have barely budged, on net, while short-term interest rates remain well below levels that would have been considered normal before 2008.
Fed funds futures contract prices are now pricing in three to four rate cuts over the balance of 2019, with more to come in 2020. However, the Fed’s posture seems to indicate that it will only cut rates in the event conditions worsen further. We do not expect rate cuts absent either a further escalation of the U.S./China trade war or a significant softening in labor market conditions. That could mean a bumpier ride for stocks and rates that are expecting help from the Fed.
Federal Reserve Statement, June 2019.
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The core PCE price index is defined as personal consumption expenditures (PCE) prices excluding food and energy prices.
The Federal Open Market Committee (FOMC) holds eight regularly scheduled meetings per year to review economic and financial conditions, determine the appropriate stance of monetary policy and assess the risks to its long-run goals of price stability and sustainable economic growth.
A word on risk
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