Fed View: July cut coming, with risk of a more aggressive move – Despite aggressive pricing for Fed rate cuts, the FOMC statement and a dovish Chair Powell press conference appeared to more than satisfy market expectations, with bond yields moving lower and equities pushing higher. Most significantly, the FOMC statement removed reference to ‘patience’ over policy, and strengthened Powell’s recent remark that the Fed will ‘act as appropriate to sustain the expansion’ by removing the qualifier ‘as always’. As well as highlighting the increased uncertainty over the outlook as the Fed’s primary concern, the statement bolstered the case for easing by pointing to ‘muted inflation pressures’. While the characterisation of survey-based inflation expectations was kept as ‘little changed’, in the press conference Powell noted that they are ‘near the bottom’ of historical ranges and expressed concern over the risk of expectations becoming unanchored.
Powell hints at 50bp cut possibility – While the ‘dots’ projections showed just one rate cut expected by the median committee member in 2020, 7 of 17 members now expect 50bp of cuts in 2019. In the press conference, Chair Powell gave this a further dovish spin by stating that even those who expected no change in policy this year nonetheless saw a stronger case for further accommodation. In the Q&A, Powell was asked about the case for a 50bp cut vs a 25bp cut, and acknowledged academic research suggesting earlier, more aggressive moves are likely to be more effective when near the zero-lower bound, stating that ‘an ounce of prevention is worth a pound of cure is a valid way to think about policy in this era’. While our base case remains that the Fed will deliver a 25bp cut at the July meeting, the tacit endorsement Powell expressed here suggests risks of a 50bp cut next month.
Could anything derail rate cuts? – Powell also countered suggestions that a US-China trade deal alone might be enough to prevent rate cuts, by pointing to the weakness in business investment and manufacturing, and the slowdown in global growth as additional factors the committee is weighing. Meanwhile, one of the most interesting changes in the accompanying projections was a significant decline in the median neutral rate estimate, from 2.8% to 2.5%. This suggests that at least part of the expectation for cuts reflects a view that the Fed may have overtightened with the last rate hike in December. This is likely what drove St Louis Fed President Bullard’s dissent at this meeting in favour of an immediate rate cut. Given the concerns over inflation as well, we do not believe a US-China truce or preliminary deal would be enough by itself to stop the Fed from cutting. Our base case remains that the Fed will implement three 25bp cuts by Q1 2020, starting at the July meeting. (Bill Diviney)