Powell Testimony & Fed Minutes Signal July Rate Cut

Powell Testimony - Dovish Press Conference

Powell Testimony during the Fed minutes were highly Dovish in tone. Wednesday was a big day for the Fed. Powell testified before the House Financial Services Committee. Also, they released the June Minutes.

Let’s start by looking at the testimony. It was completely wrong to say the market was at risk of being disappointed. Powell was very dovish in this testimony.

As you can see from the chart below, Powell’s opening testimony was the Fed’s most dovish rhetoric since 2017. Since Powell assumed office in February 2018, this was his most dovish speech.

This obviously helped stocks and pushed the expectation for the number of rate cuts in 2019 higher.

Powell stated, “Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressure remained muted.” That’s a great succinct summary of his statement.

Fed is about to cut rates in July because of uncertainties around trade

Powell Testimony -And also because inflation is low. Powell must have seen the NFIB survey. It showed the uncertainty index increasing to the 4th highest reading on record.

If the Fed is going to cut rates because of trade policy, it mitigates the trade war’s negative impact on the market. At this point, the best scenario for stocks is probably a slowdown. But also no recession or rate cuts. And, finally, trade negotiations with no progress towards a deal.

If there is a deal, then the Fed will probably stop cutting rates.

To be clear on where rates are headed, Powell stated, “many FOMC participants saw that the case for a somewhat more accommodative monetary policy has strengthened.”

Fed’s opinion on rate cuts actually moved dovishly based on the recent trade news. Even though negotiations have restarted. Solid June jobs report didn’t have a big impact on Fed policy. Even though the Fed’s mandate is to maximize employment. By the letter of the mandate, the Fed has successfully done its job.

Powell Testimony - There Is Once Again A Chance The Fed Cuts Rates By 50 Basis Points In July

The market got a double dose of Fed policy with the Minutes and the testimony. But both showed almost the same thing. Namely the Fed has continued to move dovishly.

This is much different from Bullard’s previous statement in June that a 50 basis point cut isn’t necessary. There still probably won’t be a 50 basis point cut on the 31st. But the odds have increased.

As you can see from the bottom chart below, there is either a 27% or a 23% chance of a double rate cut. The market basically regained the chance that was lost after the solid June labor report.

Fed revealed it didn’t change its mind as a result of the labor report, so this makes sense.

As the top chart shows, there is a 95% chance the Fed funds futures market is correct about this Fed decision based on data since 2006. Fed funds futures market is pricing in a 100% chance of a rate cut. Tthere’s a reasonable chance it can cut rates twice.

If the Minutes came out 2 weeks ago, the odds of 2 cuts would have increased more. Now we’re too close to the meeting for the odds to jump to 70% in my opinion. Maybe they will creep higher in the next couple weeks. Time will tell.

Fed Minutes Similar To Powell’s Testimony

Powell Testimony - Fed’s June Minutes are statements made before America and China restarted trade negotiation. And also before the recent solid labor report.

However, Powell told us in his testimony that the Fed still believes what was stated in the Minutes. Therefore, they are a reliable indicator of what the Fed is thinking about now.

Specifically, the Minutes state, “Several participants noted that a near-term cut in the target range for the federal funds rate could help cushion the effects of possible future adverse shocks to the economy. Some participants also noted that the continued shortfall in inflation risked a softening of inflation expectations that could slow the sustained return of inflation to the Committee’s 2% objective.”

Powell Testimony - The stock market likes to see conviction on a rate cut in July

But the truth is if there wasn’t support for a cut, the market would have cratered at least 2%. I wouldn’t be surprised if some FOMC members disagree with the decision to cut rates.

Especially because “some” stated more data was needed to move forward with rate cuts. Labor report gave the Fed support to maintain rates. Core PCE inflation was 1.6% in May. It definitely gives the Fed room to cut rates, but one must wonder why now?

Core inflation has been below 2% since August 2018. It was 1.5% in March and 1.6% in April. The Fed would have cut rates already if it was following core PCE exclusively.

Crosscurrents Such As The Global Slowdown

Powell Testimony - Powell stated at his testimony, “Inflation has been running below the Federal Open Market Committee’s (FOMC) symmetric 2 percent objective, and crosscurrents, such as trade tensions and concerns about global growth, have been weighing on economic activity and the outlook.”

Keyword of the day is crosscurrents. These risks make a rate cut necessary in July according to the Fed. That’s the explanation the Fed will give in its statement. I don’t need to wait until July 31st to figure that out.

Another aspect is that the Fed is cutting rates because the global economy is slowing.

Powell Testimony -Fed must have reviewed the JP Morgan global PMI index which was steady at 51.2 in June. On the positive side, new orders were up from 51.3 to 51.6. On the negative side, future output fell from 59.8 to 59.4.

18 of 30 manufacturing PMIs were in contraction and 3 of 13 services PMIs were in contraction. America is one of the strongest economies. Imagine how much it would be outperforming by without the uncertainty of the trade war.

Good news for American companies is the Fed’s dovishness is a negative for the dollar. Without the Fed cutting rates, the dollar would be much stronger.

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1 Comment

  • Jeff Tino

    July 11, 2019

    Does anyone ever read the articles? They are fantastic! Just thought I'd add a comment after reading a bunch of these and realizing I don't think I've ever seen a response:-)