Executive Summary

Regardless of one's position on the necessity of three consecutive rate cuts this year, the way the FOMC's hand was played looks reasonably favorable with the benefit of hindsight. The recession warning from an inverted yield curve has gone from flashing red to yellow as some positive slope has returned to the curve.

Having now entered the blackout period when Fed officials refrain from public comment, we offer our latest installment of our Flashlight for the FOMC Blackout Period. We expect the FOMC will keep rates unchanged at its December 11 meeting. With the Fed signaling it will be on hold for at least its upcoming meeting, the focus has already shifted to what comes next. With "insurance" taken out, it will now come down to how the economy is performing. The December meeting will also provide an update to the FOMC's economic outlook through its Summary of Economic Projections. Based on the most recent data, we do not anticipate any meaningful adjustments to GDP and unemployment projections for this year or next.

With respect to the balance sheet, we expect that the Fed will eventually create a standing repo facility (SRF) that will be available on a "permanent" basis. But because we do not expect that any SRF will be operational until next year, we think it is a bit premature to expect that technical details of such a facility will be announced at next week's meeting.

 

The Economy Has Decelerated, But Not Markedly

Starting with the first rate cut in almost a decade in July, the Federal Open Market Committee (FOMC) has followed on with two more cuts in successive meetings. The top end of the fed funds range is now at 1.75%, 75 bps lower now than it was in the first half of the year.

At the beginning of this current rate-cutting campaign, it was not entirely clear that the economy was in need of rescue. Consumer spending was strong, and, while hiring may have cooled, the labor market was still tight with the unemployment rate near a 50-year low. But, inflation measures had been running a bit below the Fed's target rate, which offered policymakers the justification to cut rates and remain within the spirit of the dual mandate.

The FOMC has made no secret about the primary reasons for the rate cuts: concern over slowing global growth and worries about what that could mean for the economic outlook, even if coincident measures suggested the economy is still in good health. But those risks have eased over the past month or two. After a sharp escalation in the trade war, talks for at least a partial deal have resumed. In addition, the imminent risk of a hard-deal Brexit has also subsided.

Meanwhile, the economy continues to weather current headwinds. Global growth remains anemic, but the latest purchasing managers' indices from the Eurozone and China suggest momentum is at least not worsening. The same largely holds true in the United States, where the ISM manufacturing index remains below the demarcation line separating expansion from contraction, but data on core capital goods orders hint at a modest rebound in business investment in the current quarter.

Perhaps most importantly, there are few signs of slow global growth and investment weakness spilling over into the labor market. Job growth was stronger than expected in October and prior hiring was revised significantly higher. All told, job growth does not appear to be slowing to the extent feared. The continued strength in the labor market suggests only a modest deceleration in consumer spending after the breakneck pace of growth this summer.

Despite the recent rate cuts, however, inflation has remained subdued. Core PCE inflation dropped back to 1.6% year-over-year in October after two soft monthly readings of 0.1%. That said, longterm market and consumer inflation expectations remain unaltered, while the Trimmed Mean PCE deflator shows the underlying trend in inflation remains at 2.0% (Figure 1).

fxsoriginal

Source: U.S. Dept. of Labor, Federal Reserve Bank of Dallas, Bloomberg LP and Wells Fargo Securities

Regardless of one's position on the necessity of three consecutive rate cuts, the way the FOMC's hand was played looks reasonably favorable with the benefit of hindsight. The recession warning from an inverted yield curve has gone from flashing red to yellow as some positive slope has returned to the curve. Financial conditions have eased since early October and remain accommodative relative to pre-crisis norms (Figure 2). Overall, the economic and financial data since the Fed's last meeting suggest the expansion remains positioned to continue.

fxsoriginal

 

What Rate Decision is on Tap for December?

We expect the FOMC will keep rates unchanged at the December 11 meeting. After perhaps some of the most discordant meetings of the cycle, policymakers appear to be back on the same page. FOMC members in the "insurance" camp appear satisfied for the time being with the 75 bps of easing done to date. After all, risks have leveled off to some extent, and it will take some time for the accommodation to work its way through the economy. Meanwhile, members who were more apt to cut only once weakness in the U.S. economy became more evident are not so worried about high inflation or financial imbalances to push for taking back recent cuts. And so, the FOMC likely will remain on hold on December 11.

Financial market participants appear to be on board with the "on hold" signal coming from the committee. Currently, markets are pricing in only a 5% chance of a rate cut in December. At the same time, equity markets are hovering near all-time highs, credit spreads are near the year's tightest and financial conditions remain broadly accommodative. In other words, markets do not appear to think the economy is in need of further support at this time.

 

The Dot Plot: Looking Ahead to 2020-2022

With the Fed signaling it will be on hold for at least its upcoming meeting, the focus has already shifted to what comes next. With "insurance" now taken out, it will come down to how the economy is performing. Said differently, it is back to data dependency rather than risk dependency. Chairman Powell noted during his press conference following the last FOMC meeting that the committee will need to see a "material" weakening in the outlook before cutting rates again.

The December meeting will also provide an update to the FOMC's economic outlook through its Summary of Economic Projections. Based on the most recent data, we do not anticipate any meaningful adjustments to GDP and unemployment projections for this year or next (Figure 3). The median estimates for both GDP and the unemployment rate should remain favorable relative to longer-run estimates. Expectations for core inflation may sink a bit further below 2%, however. With inflation still expected to struggle to meet 2%, let alone rise above it for a time to demonstrate the "symmetric" nature of the target, we would expect the Fed to maintain its easing bias.

fxsoriginal

Source: U.S. Department of Commerce, Federal Reserve Board and Wells Fargo Securities

The easier policy stance the FOMC has settled upon is likely to become evident in the dot plot (Figure 4). The fed funds rate is already below the median estimates for 2019-2022. The extent to which the dots shift lower over the next few years will offer some clues as to whether officials think they can reverse this year's "mid-cycle adjustment".

fxsoriginal

 

What Else Does the FOMC Have on Its Plate?

Although discussion tends to center around what the FOMC will decide regarding its target range for the fed funds rate, there has been no shortage of action with its balance sheet tools as well. Following a surprising amount of volatility in money market rates in mid-September, the Fed announced its intention to purchase T-bills at least into the second quarter of 2020 with a stated objective of maintaining reserve balances "at or above the level that prevailed in early September 2019." As we noted in a report at the time, the move should not be interpreted as a return to quantitative easing (QE). Through its QE purchases, the Fed intended to put downward pressure on long-term interest rates. In contrast, by pumping liquidity into the banking system via its purchases of short-dated T-bills, the new operation is intended to prevent a re-occurrence of volatility in money market rates. Although we believe that the FOMC will want to keep its options open, at least through the end of the year when short-term funding pressures seem to be greatest, we will be watching for any guidance that the committee may give regarding its planned purchases in the first few months of 2020.

Not only did the Fed announce T-bill purchases to relieve funding pressures, but it also has been conducting overnight and term repurchase operations (repos) as a tactical maneuver. As we wrote in our aforementioned report, we expect that the Fed will eventually create a standing repo facility (SRF) that will be available on a "permanent" basis. But because we do not expect that any SRF will be operational until next year, we think it is a bit premature to expect that technical details of a such facility will be announced at the conclusion of next week's meeting.

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Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.

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