Wednesday FOMC Preview - No Cut Coming

Wednesday FOMC Preview - June FOMC Forecast: No Cut

Looking at the Wednesday FOMC Preview produces a couple of surprises. The table below is a summary of expectations for the June Fed meeting made by Oxford Economics. I will review each point.

Firstly, the Fed won’t cut rates on Wednesday. I’m highly certain the Fed won’t cut rates in June. It hasn’t mentioned cutting rates before and this isn’t an emergency.

The Fed mentioned patience in its May statement. And solid industrial production and retail sales reports were just released. I think those claiming there will be a surprise cut or a surprise double cut, which is 50 basis points, are just trying to make headlines.

These guesses can generate publicity for the people making them and generate clicks for the websites that post them.

Fed would lose all credibility if it went from patience to a cut based on some moderately weak data.

Wednesday FOMC Preview - Blue chip consensus estimate for Q2 GDP growth shown in the Atlanta Fed Nowcast was at 2% on May 5th. Surely, if the Fed was planning to cut rates, it would have said so in the past 5 weeks.

Estimate is now at 1.7% which isn’t much of a difference. Point is, we’ve known Q2 headline growth wasn’t going to be great for a while. CME Group shows the Fed funds futures market is pricing in a 20.8% chance of a cut.

Cuts usually occur when there is at least a 70% chance of one. If the Fed cuts rates on Wednesday, it would shock the market instead of calming it because investors would be wondering what the Fed sees/knows that they don’t.

Wednesday FOMC Preview - No More Patience

In its statement, the Fed will replace “patience” with “closely monitoring” recent developments. Whatever the Fed writes in its statement, there is no way it includes the word patience.

Patience means no cuts in the future. Even if the Fed waits until July to cut rates, I think patience was misused back in May. Now that it’s obvious the Fed will cut rates this year, patience will be gone. Even if the Fed isn’t certain it will cut rates in July, cutting must at least be an option.

With the economic slowdown and decline in inflation, there’s no reason to take cuts off the table. If the Fed is determined to not cut rates this year, it could cause stocks to fall 10%.

If the Fed were to take policy control away from the futures market, it would be cutting off its nose to spite its face.

Wednesday FOMC Preview - Fed should be gentler about guidance rather than staunchly going against the market.

As you can see from the chart below, the FOMC has had more accurate 2 year projections of future policy than the market. That means the expectation for 3 cuts this year could be wrong.

However, it’s unlikely the virtual certainty (95.6% chance) that there will be at least one cut by September will be wrong.

Fed’s Guidance

Wednesday FOMC Preview - Oxford Economics’ prediction for Fed guidance is for rates to stay at 2.38%. This is my first disagreement as I expect the Fed to guide for one cut. I understand why Oxford Economics predicted this.

Once the Fed guides for a cut, it’s tough to reverse course. You can’t put the genie back in the bottle. However, if the Fed doesn’t guide for a cut, the market will be upset and anxious.

It will probably fall at least 1% on Wednesday. At that point, the only thing that could save the bulls is a trade deal with China.

Personally, I think it’s reasonable to guide for a cut and if there’s a trade deal, either rescind it or hike rates in 2020. It’s usually tough to reverse course on cuts as the Fed usually guides for hikes way ahead of time, but switches to cuts quicker.

However, if there is a firm trade agreement with China that causes a spike in economic activity, this will be an exception to the rule. If the Fed guides for one cut this year, the market probably won’t have a big reaction. It leaves open the possibility for more cuts like the market expects.

If the Fed doesn’t guide for a cut, it pretty much makes it impossible for the Fed to cut rates 3 times this year unless the economy falls off a cliff in the 2nd half.

Oxford Economics has the Fed getting rid of its one hike in 2020.

Wednesday FOMC Preview - I agree that the Fed won’t guide for any hikes or cuts in 2020. I just think the median rate will be lower because of the guide for a cut in 2019. That would bring down the median by 50 basis points.

Next it says the range of projections for 2019-2021 will be lowered and some Fed members will see cuts in 2019. Since I see the Fed guiding for a cut, investors obviously expect many members to forecast cuts.

Finally, it says the long run neutral rate might be lowered. I think the Fed will keep that rate the same. A rate cut will put rates below the neutral rate, which makes sense because the Fed is trying to end the slowdown with this possible September cut.

Wednesday FOMC Preview - Economic Forecasts

I agree that the GDP and unemployment forecasts will fall since Q2 GDP growth is expected to be 1.9% and the May CPI report missed estimates.

Unemployment rate keeps falling below the Fed’s estimate. NAIRU rate is weird. We have unemployment at a rate that should generate inflation. But inflation has been falling recently.

Balance Sheet

Wednesday FOMC Preview - The balance sheet run off will continue until September. It would be interesting to see the Fed cut rates in September while still unwinding the balance sheet because the run-off is considered hawkish and a rate cut is dovish.

If the Fed ends the run-off earlier, it’s not a big deal. Long term balance sheet guidance doesn’t mean much because it can be changed easily. The Fed could use QE again in the next recession.

Tools are in the Fed’s chest, but I’m not 100% sure if the Fed thinks QE will help the economy in the next recession. Fed probably won’t do QE if the trade war causes a recession.  

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