Fed View: Noncommittal but with a dovish bias – Our main takeaway from the September FOMC is that the Committee sees risks to the outlook as having intensified since the July meeting, but not to the degree that it feels the need to telegraph additional aggressive easing at this stage. The Fed cut its target range for the fed funds rate by 25bp, while the quarterly projections showed the median Committee member expected no further cuts beyond today’s move. A sizeable minority (7 of 17 members) expect one further cut this year, but surprisingly even the most dovish members of the Committee did not expect more than one additional rate cut; we would have expected more dovish members to favour two more cuts beyond today’s move. This suggests the risk to our view is tilted towards the Fed cutting less than the two cuts in our base case. However, we continue to expect a further weakening in the macro data over the coming months, and on balance we expect this to ultimately drive the Fed to cut by more than it is currently signalling (see our preview for more). Indeed, in signalling this possibility, Chair Powell notably avoided repeating the ‘mid-cycle adjustment’ phrase used at his last press conference, pointed to ‘additional signs of weakness abroad and a resurgence of trade policy tensions’, and said that, while not the Committee’s expectation, ‘a more extensive sequence of rate cuts could be appropriate’ if the economy turns downward.
Resumption of balance sheet expansion could also have implications for policy – A further risk to our view comes from the recent funding market problems and the Fed’s response to this. In addressing this, we thought the Fed might speed up a decision on a permanent Standing Repo Facility. However, Chair Powell indicated in his press conference that the Fed’s preferred method would be to deal with the shortage of excess reserves directly by resuming ‘organic growth of the balance sheet (…) perhaps earlier than we thought’ such that ‘frequent [repo] operations would not be required’. When pressed on whether there might be a need for a ‘more than organic’ expansion of the balance sheet to get back to an appropriate level of excess reserves, Powell did not dismiss this idea, only to say that the Fed would continue repo operations in the coming days if needed and use this process to gauge the likely shortage of excess reserves.
Long run repo loans or asset purchases are options to expand balance sheet – While the Fed will rightly stress that such a balance sheet expansion is purely to address issues of market functioning, it is unclear how this would be implemented, whether through net asset purchases or perhaps through a longer term lending facility (to satisfy the condition of ‘frequent operations’ being unnecessary). A resumption of net asset purchases would represent an easing of monetary policy, and all else equal, this could well reduce the need for rate cuts relative to the baseline, depending on the degree of balance sheet expansion that becomes necessary. This could present a communication challenge for the Fed, and as such, a longer term lending facility looks more likely at this stage. (Bill Diviney)