The Federal Reserve Keeps its Options Open

The Federal Reserve’s two rate cuts in as many months have satisfied market expectations for action and will give the governors time to determine if a full reduction cycle is warranted. The bank’s economic projections and a divided FOMC indicate that the members are not convinced that more rate cuts are needed just now.

Generally positive economic data in the six weeks since the last Fed meeting and calm in the US China trade dispute and an October resumption of negotiations have removed the immediate causes for further easing.

The board’s upbeat view of the economy was reflected in the revised estimate for this year’s GDP which rose from 2.1% to 2.2%. The adjustment was small but coming after two precautionary rate decreases it suggests that the Fed’s fears may have been overstated.  

The fed funds are now expected to be 1.9% through the end of 2020. With the target range 1.75%-2.00% after yesterday’s 25 basis point cut, that implies no rate moves for the next 15 months.

Chairman Powell reinforced the positive view of the Projection Materials noting that “We expect the economy to expand at moderate pace,” and “Consumers have spent at a healthy clip”. 

The slowdown in job creation this year, from 245,000 in the non-farm payroll three-month average in January to 156,000 in August does not seem to have worried the governors.  If there was serious concern that the labor market was fading it is highly unlikely the board would be holding off on subsequent cuts.

Reuters

Indeed the projections show unemployment remaining below 4.0% to the end of 2022, with 3.7% this year and next, 3.8% in 2021 and 3.9% in 2022.  Initial jobless claims, which have been near five decade lows for more than a year, back up the sense of a tight labor market. Core PCE inflation is expected to be 1.8% this year, 1.9% in 2020 and 2.0% in the following year.

The Fed’s somewhat unusual rate policy for the past two meeting has not been based on US economic performance but on the risks to expansion from trade policy and Brexit uncertainty and a general slowdown in global growth.  In that the governors reflect the business community particularly in manufacturing which has largely ceased investment waiting for a resolution the US China dispute.

That trade risk has not dissipated even if it is in abeyance at the moment and the FOMC statement says, as it has for several meetings, that the board will act as necessary to sustain the expansion.

Because the US economy has not weakened appreciably from the trade threat it is difficult for the governors to know the impact of the current policy. The 7-3 vote mirrors that dilemma. As at the July meeting Eric Rosengren of Boston and Esther George of Kansas City elected to leave rates unchanged and James Bullard of St. Louis supported a 50 basis point cut. 

The so-called dot plot of the rate forecasts of voting and non-voting members depicts the same division. Five indicate they think the Fed has does too much, seven that it has done too little and five that the response has been on target.

For the next several months data will again have the focus.  If the economic information remains as it is a rate cut at the end of October is improbable, though the overall policy and risk is biased towards accommodation.  The most recent statistics, industrial production which rose 0.6% in August and housing starts tilt toward firm growth and retail sales have been robust. 

Reuters

Having emphasized rate stability for the moment it would take a serious deterioration in US economic results or an escalation in the trade conflict for the Fed to cut in six weeks.

Chairman Powell’s comments carefully kept the Fed’s policy options open, expect them to remain so for some time.