Although Powell doesn’t tip his hand, most expect more cuts this year

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Market observers still expect more interest rate cuts, even after Federal Reserve Board Chair Jerome Powell refused to tip his hand and the Summary of Economic Projections released Wednesday suggested the easing in credit is done.

“The divided Fed resulted in a median expecting no further cuts this year or next, though seven of 17 participants are open to cutting further, six of which are voters,” according to a note from Morgan Stanley Research. “We expect downside risks to the outlook to remain and look for the Fed to deliver an additional cut of 25bp in October, though Powell was careful not to telegraph future moves.”

In his press conference Powell stressed the outlook is positive. “This message from the Fed is that we are not on the verge of a recession, and there is no reason to expect massive further monetary easing,” said Sonal Desai, CIO of Franklin Templeton Fixed Income Group.

And the yield curve, she added, “does not tell much about the U.S. economic outlook.” But the “Fed backed itself into a corner” by capitulating “to market expectations of rate cuts. Yesterday, it has gone some ways toward extricating itself, making a stronger case for waiting to see the impact of these rate cuts — and reiterating that the U.S. economy remains solid,” Desai said

“While this move was widely anticipated bond prices still rose on the news, adding to 2019's gains,” said Marc Odo, client portfolio manager at Swan Global Investments. “Bonds have burned up a lot of their fuel for the next several years. The yield curve remains flat, with scarcely any point offering yields in excess of 2%.”

Bondholders may be “in a lose-lose situation. If rates continue to fall, bondholders will see a bump in prices, but will be saddled with paltry yields likely to fall short of inflation. If rates increase, bondholders get whipsawed and will see the value of their bond holdings fall,” said Odo.

Mickey Levy, Berenberg Capital Markets' chief economist for the U.S. Americas and Asia, and U.S. Economist Roiana Reid, also said the voting participants on the FOMC tend to favor more cuts, while those opposed are non-voters. “We forecast that the Fed will cut its policy rate once more, by 25bp, in Q4 2019 to 1.50-1.75%.”

Despite this, Levy and Reid write, “the July and September rate cuts will have little impact on economic activity or lift inflation, and by reducing the policy rate closer to the effective (zero) lower bound, the Fed risks reducing its future flexibility to respond appropriately to a future recession.”

While the cuts will offer a boost to the housing market, “by highlighting its overwhelming concerns about downside risks related to uncertainties, the Fed reinforces negative business sentiment that constrains business investment and expansion,” they said.

Powell said the balance sheet size would be revisited but noted any change would be operational in nature, not a monetary policy action. “It is possible that the Fed shrunk its balance sheet a bit too much, underestimating reserve demand,” Levy and Reid said.

The post-meeting statement and Powell’s appearance “does little to reduce uncertainty,” said Mortgage Bankers Association Chief Economist Mike Fratantoni. “The trade war with China, and now conflict in the Middle East, certainly add to the overall uneasiness. While it is not surprising that FOMC voters cannot agree on the outlook for monetary policy, as indicated by the three dissenting votes today, the disagreement itself also adds to the uncertainty,” Fratantoni said.

“What is striking is that the Fed’s central case projections for the economy have not budged since June – in fact they’ve revised up 2019 growth,” said Brian Coulton, Chief Economist at Fitch Ratings. “But the sharp escalation in the U.S.-China trade war in August has increased the downside risks to the U.S. economy from slowing external demand and increased caution on capex on the part of U.S. firms. While the Fed has maintained it ‘will act as appropriate’ language, we still see this as an insurance policy move and don’t expect a series of further rate cuts.”

“The Fed's lack of conviction in signaling more rate cuts will probably be a policy mistake that is wasting the effectiveness of the first two rate cuts,” said Edward Moya, senior market analyst, New York at OANDA. “The Fed seems set on waiting for a couple geopolitical risks to rattle the economy before committing to a full-pledged easing cycle.”

When asked if he still viewed this as a mid-cycle adjustment, Powell said, "if the economy weakens, more extensive cuts may be needed." Moya said, “with the downside risks likely to linger for quite some time, markets should remain confident more rate cuts are on the horizon.”

He added: “The Fed failed to stay ahead of the curve in delivering a clear steepening of the yield curve and we will likely see them pressured at the next meeting.” Moya said he expects another easing in October “and possibly another one in December.”

Although the dot plot suggests no more cuts through the end of 2020, Stephen Gallagher, U.S. chief economist at Societe Generale, pointed out the June Summary of Economic Projections also made that suggestion, “yet after June, the Fed cut rates twice. The risk is for further cuts.”

The key he said, is the reiteration that the Fed "will act as appropriate to sustain the expansion."

The Fed will hold “for a few months at a minimum unless there is significant economic weakness or a breakdown in trade talks,” said Marc Pfeffer, chief investment strategist at CLS Investments, although the market is expecting one more cut this year. Bond yields will likely remain in a narrow range.

“There was no guidance for the October meeting,” said George Boyan, president of Leumi Investment Services, Inc., “So, as we wait for the October meeting we will watch the U.S. economic data, the global economic data, and developments in the tariff war. Watching, just like the Fed.”

“While some major corporations in the U.S. do not see a rate cut as being critical, central banks are slashing rates globally,” said Nick Tsafos, partner, financial services growth leader and chairman of EisnerAmper Global. “We do not see this new rate as a lasting impact on the macro economy.”

But still, some thought the Fed should have sent a stronger message. “The interest rate cut is the right decision, but should have been bolder with a 50 basis point move,” said NAR Chief Economist Lawrence Yun. “The indication of another rate cut in a few months will simply hold back some consumer and business decisions until then. It would have been better to get the economy going right away.”

With mild inflation, slowing economies here and abroad, and other central banks easing, he said, “Another rate cut in the U.S. by the year’s end is nearly assured.”

“There’s much uncertainty amongst economists, and within the Fed itself,” said Nigel Green, founder and CEO of deVere Group. “It’s an unusual environment.”

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Monetary policy Jerome Powell Federal Reserve FOMC
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