Global Daily – Dovish Fed, and communication challenges

by: Bill Diviney

Fed View: Dovish tweaks spur rate cut expectations – The FOMC kept policy on hold today, and only two small changes were made to the policy statement, albeit both dovish: 1) ‘strong’ was replaced with ‘moderate’ to describe household spending, 2) language around the 2% inflation target was changed from wanting inflation ‘near’ 2% to returning it ‘to’ 2%. On the latter, Chair Powell clarified in the press conference that this was to avoid the possible misunderstanding of the Fed’s goal as being asymmetric below 2%, rather than symmetric around 2% (i.e. that an undershoot of 2% is just as undesirable as an overshoot of the target). This fits with what is likely to be a tweak to the Fed’s inflation target following the ongoing policy framework review – the result of which is due midyear – where we expect the Fed to emphasise that symmetry, with the goal of boosting inflation expectations over time.

Powell also sounded dovish on pipeline inflationary pressures. While reiterating the usual line that he expects inflation to move ‘closer to 2% in the coming months’, he noted that it is ‘surprising wages haven’t risen faster’, and that the ‘labour market is possibly not as tight as thought’ – likely a reference to the recent deceleration in wage growth. Finally, on the broader growth outlook, Chair Powell kept to the more neutral tone of recent meetings, contrasting signs of a stabilisation in global manufacturing with continued trade policy uncertainty (despite the recent trade deals) as well as from the recent coronavirus outbreak.

Treasury yields nudged lower and rate cut expectations increased modestly during the press conference. Indeed, market pricing of cuts has moved from one cut to almost two cuts by the end of 2020, following the recent coronavirus outbreak, although most of that easing is priced to come in the latter half of the year. Our base case is that weaker growth will drive one more ‘insurance’ cut in the first half of 2020, with policy likely on hold thereafter. The Bloomberg consensus currently expects policy to remain on hold this year and next.

Technical IOER hike, and balance sheet communication challenges – As we had flagged in our preview, the Fed raised the IOER rate by 5bp to 1.60% from 1.55%. This partially reversed the cuts it made to this rate in 2018-19, and the Fed was able to do this because the fed funds rate – and broader funding market conditions – are now much more stable following the start of repo market operations and T-Bill purchases. The move is purely technical, with no implications for the policy stance, and is intended to bring the fed funds rate closer to the middle of the target range of 1.50-1.75%. Chair Powell was also repeatedly questioned on the Fed’s recent T-Bill purchases and whether they constitute QE. Our view is that they do not, as we explained in a prior Global Daily Insight, but as we had expected the Fed is clearly facing a communication challenge with this policy. This will probably be resolved when the purchases themselves come to an end, likely in the middle of the year. However, there is a risk that a segment of investors are indeed viewing the purchases as QE – and acting on that basis – with a potentially negative financial market reaction when these purchases do come to an end.