Federal Reserve Preview July 30-31 FOMC: Is this a rate cut cycle?

• Fed Funds expected to be cut by 25 basis points to 2.00%-2.25%
• First rate reduction since December 2008
• Rate guidance for the remainder of the year most important

The Federal Reserve will conclude its scheduled two day policy meeting of the Federal Reserve Open Market Committee on Wednesday July 31^st.  The central bank will issue its decision for the fed funds rate at 2:00 pm EDT, 18:00 GMT. Chairman Jerome Powell will read his statement and hold a news conference beginning at 2:30 pm EDT, 18:30 GMT

Federal Reserve policy

In what is probably the most highly anticipated FOMC meeting since the Yellen Fed began raising the fed funds rate in December 2015 following almost seven years at 0.25%, the governors are universally expected to cut the base rate by 0.25% to a target range of 2.00%-2.25%.

This decision is unusual in several ways. First because the US economy does not appear to need the support promised by rate reductions. Economic growth is healthy, the labor market is booming, jobs are plentiful, wages are rising at the best pace in a decade, consumer spending is firm and the unemployment rate and initial jobless claims are at five decade lows. 

Reuters

Although inflation is below the Fed’s 2% target and has fallen from 2.0% to 1.6% in the first half of the year, weak price pressure has been the case for most of the three year cycle that brought the fed funds from 0.25% to 2.5%. 

Reuters

The Fed’s notice of inflation was largely rhetorical then, forecasting a return to its target that never quite took place.  Zero interest rates and several rounds or quantitative easing in prior years did little to raise inflation though the Fed has said that the programs did prevent deflation.

The Fed’s economic logic for a rate cut relies on the threat of global factors to the US economy. The governors are concerned that the slowdown in global growth, itself in part produced by the US instigated trade dispute with China and the British exit from the European Union could damage the long running US expansion.

Chairman Powell has also cited the bank’s desire to keep the labor market, which is delivering jobs and wage gains into previously hard to reach social corners of the populace, humming.  The tight labor market pressure that is extending these benefits would be severely diminished or lost if the economy slows or enters a recession. One of the Fed’s Congressional mandates is full employment.

In effect the Fed is taking out an insurance policy to insulate the economy from any potential damage from the global environment.  

A new rate cycle?

Six months ago the Fed was still raising rates. Historically, when the Fed initiates a change in policy it begins a cycle that intends to support or curtail the economy with a series of rate moves and a change of several percentage points.

This time is it not at all clear that is the Fed’s intent. While the futures and the credit markets anticipate a much lower fed funds rate in a year the Fed itself has been ambivalent.  

The fed funds futures for the April 29^th, 2020 meeting show a 73.8% chance of three or more rate cuts by that date with a maximum rate of 1.75%. 

CME Group

The Fed’s own projections from the June 19^th FOMC have the year-end rate at 2.4% this year and in 2020 at 2.1%.

Federal Reserve

Credit market prediction

The credit markets have been a better predictor of Fed policy than the Fed itself. Yields on 2 and 10-year Treasuries began to fall in early November 2018, six weeks before the Fed’s last rate hike on December 19^th. If the FOMC does drop the fed funds on the 20^th that would be eight months after Treasury yields began their descent.

Reuters

Therein lies the uncommon interest in this FOMC meeting.  The American economic reality does not yet back up the Fed’s or the credit market’s concerns.  The China trade dispute and the UK exit from the European Union are thought to have great potential to damage global and US growth but so far the impact has been minimal.

The credit markets indicate that the worries are real enough to take out a substantial insurance policy. So do the central banks of Australia and New Zealand who have each dropped their base rates by 0.5%, while the Bank of England and the Bank of Canada have stayed pat.

Reuters

The market has laid out a specific path, the Fed has acquiesced but not wholly agreed and the future is very much up in the air.