FOMC Preview: Running out of patience – The Fed is widely expected to keep rates on hold when the June FOMC meeting concludes on Wednesday. However, we expect the Fed to signal via multiple channels that it is moving towards an easing of monetary policy over the coming months. Our base case is that the Fed will cut interest rates three times by Q1 2020, with the first 25bp cut occurring at the July meeting (see here, here and here for more on our change of view). Given the extent to which market pricing has moved, it looks difficult for the Fed to ‘out-dove’ what is already priced in (three full 25bp cuts by Q1 2020). With that said, markets often take more lead from the direction in FOMC signalling rather than the scale of the shift per se.
From neutral to an easing bias – We see scope for a number of important changes to the statement. The most likely change will be to remove the reference to the committee being ‘patient as it determines what future adjustments [to rates] may be appropriate’. This statement suggested a neutral stance, with no imminent change to policy likely. We expect this to be replaced with something similar to Chair Powell’s recent remarks that the Fed ‘will act as appropriate to sustain the expansion’. This would suggest a potentially imminent easing of monetary policy, which would support our view that the first cut will come in July.
Declining inflation expectations – We also see a good chance that the Fed will change its reference to survey-based inflation expectations, which in the May statement it described as ‘little changed’. This is based on four surveys – the Michigan survey, the Philadelphia Fed’s Survey of Professional Forecasters, and the NY Fed’s Surveys of Primary Dealers and Market Participants. Long-term inflation expectations have since declined in three of these four surveys; in the case of the Michigan survey, 5-10 year inflation expectations fell to an all-time low of 2.2% in June. Given the staff expectation in the May FOMC minutes for core PCE inflation to ‘run just below 2%’ even over the medium term (previously, staff expected inflation to ‘edge up to 2%’ over the medium term), the structural decline in inflation expectations will be disconcerting to FOMC members, bolstering the case for an easing in policy.
Dots to shift, but not aggressively – Finally, we expect the quarterly ‘dot plot’ rate projections to signal a shift to easing. As of the March projections, they continue to show one expected hike in 2020. At the very least, we expect this hike to be removed; more likely than not, one rate cut will be projected for this year or next. However, the Fed is unlikely to be overly aggressive in explicitly signalling cuts at this stage, as it will probably want more time to see how both the trade war and the macro environment evolves before determining the timing and the extent of any easing. (Bill Diviney)