Fed Cuts Rates 25 Basis Points & Powell Gives No Signal For More Cuts
The Fed cut rates once on Wednesday which is exactly what the market expected. Initially, there was no stock market reaction to the decision and statement. Then stocks sold off after Powell stated there wasn’t necessarily a plan to further cut rates. Other moves were reducing the IOER by 30 basis points and setting up Open Market operations to make sure the Fed has control of short term rates.
Finally, the Fed stated there will be an organic rise in the balance sheet. Normally, this wouldn’t be news at all, but because the Fed just finished the QE unwind, everyone is focused on the balance sheet. This isn’t a major policy change. It’s simply to help the Fed bring the repo market under control.
Changes To The Fed’s Statement
Now we've looked at policy changes, which were in line with expectations besides the hawkish guidance, let’s look at the changes to the Fed’s statement. It’s no wonder the stock market didn’t react to the Fed’s statement. There were barely any changes.
As you can see, instead of saying “growth of household spending has picked up”, the Fed said, “household spending has been rising at a strong pace.” The consumer’s strength has continued. That’s based on Q2 consumption growth and the past few solid retail sales reports. Next, the Fed stated, “business fixed investment and exports have weakened” instead of just saying “business fixed investment has been soft.” Net exports hurt Q2 GDP growth and it might hurt Q3 growth as well.
Obviously, the Fed got rid of the point about ending the balance sheet unwind. Critics of the Fed point out the balance sheet upwind just ended a few weeks ago and the Fed is already expending its balance sheet again. They claim this is another QE.
However, they also criticize the Fed for losing control of the Fed funds rate. This isn’t another QE. This is an organic rise that wouldn’t need to be announced as policy under normal circumstances. These aren’t normal circumstances because the repo market went out of control and the Fed has used the balance sheet as a policy tool this cycle.
Many Disagreements
A most interesting part of the statement is how Fed members voted. Some members won’t be voting next year. This is their last chance to put a stamp on monetary policy. Specifically, there were 3 dissenters which is the most since 2013. It’s not a surprise there was this much disagreement because no one is sure how bad this slowdown will get.
Some see a recession in the next 6 months and some see this slowdown ending soon. I’m in the latter camp, but I think Q3 GDP growth will be weak. It could be below 2%.
Rosengren and George were in favor of rates staying the same at this meeting, while Bullard was in favor of a 50 basis point cut. I don’t understand why there needs to be such a large cut since we just got a great retail sales report and an industrial production report that beat estimates. There might be an interim trade deal next month. Why cut rates so quickly?
Powell’s Press Conference
A 50 basis point cut would limit the Fed’s ability to fight the next recession which likely hasn’t started yet. The Fed is working under the assumption that it won’t cut rates to the negatives.
Powell stated, “I do not think we’d be looking at using negative rates, I just don’t think those will be at the top of our list. If we were to find ourselves at some future date again at the effective lower bound, again not something we are expecting, then I think we would look at using large scale asset purchases and forward guidance.”
Fed has previously not been so keen on doing another round of QE, but it’s no surprise Powell stated the Fed would rather do another round of QE than cut rates below zero. Negative rates would be much more extreme monetary policy. Personally, I don’t see negative rates coming soon, but I wouldn’t rule it out.
There are 2 scenarios where negative rates could come into play in the next 2-3 years. The first is if the economy weakens over the next year and the Fed continues to cut rates. Then a recession starts in late 2020 and the Fed has little room to cut rates to deal with it. The 2nd is if there is a deep recession. I see little chance of a deep recession as there isn’t excess in the economy.
Now let's review the statement Powell made in his press conference that caused stocks to fall and some to call this a hawkish cut. Powell stated, “If the economy does turn down, then a more extensive sequence of rate cuts will be appropriate. We don’t see that. It’s not what we expect. We made one decision today, and that decision was to lower the funds rate by a quarter percentage point. We believe that action is appropriate to promote our objectives. We’re going to be highly data dependent. I would also say as we often do that we’re not on a preset course.”
Powell is trying not to admit the Fed was wrong about the July cut being a mid-cycle adjustment. 3 cuts isn’t an adjustment when the Fed funds rate is this low.
Latest Economic Projections
Fed updated its economic projections from June at this meeting as you can see from the table below. The Fed actually sees higher 2019 real GDP growth than in June (2.2% instead of 2.1%), yet it has cut rates twice since then. That’s inconsistent to say the least. It also expects a 0.1% higher unemployment rate.
Instead of expecting the Fed funds rate to be 2.1% in 2020, it sees the rate at 1.9%. It also sees rates at 1.9% in 2019 which probably will change. I expect a cut in either October or December. There is a 58.7% chance the Fed will ease again this year. The Fed is oddly hanging onto a cut in 2021 which is meaningless given how much the Fed changes its guidance.
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