FOMC preview: Cut, dissent, no good answers expected
While the Federal Open Market Committee is likely to cut interest rates at its Oct. 30-31 meeting, analysts say the vote won't be unanimous. The dissent may hold the key to future moves, as economic indicators suggest rate cuts are not needed, while trade issues, a flat yield curve and low inflation suggest otherwise.
A 25 basis point cut would bring the rate to a range of 1.5% to 1.75% and would mark the third consecutive meeting in which the panel cut rates.
“We expect the Fed to cut their target rate by 0.25 percent this month,” said Bill Merz, SVP and head of Fixed Income Research for U.S. Bank Wealth Management. “Messaging is likely to remain consistent and the most useful data out of the meeting may be who and how many members vote against cutting rates.”
This split at the Fed will make it difficult to achieve “meaningful policy changes” in the near term, he said. “Trailing economic data is strong enough to justify an end to the mini-cycle of rate cuts but market signals like the flat yield curve and anemic inflation expectations indicate additional easing is necessary.”
And while the press will pepper Chair Jerome Powell “about the likelihood of further cuts, repo and balance sheet issues, and dissenting views,” Merz said, they “are unlikely to receive satisfying answers. Chairman Powell has been consistent in downplaying hot-button issues including forward guidance and funding market problems, while repeating the mantra of data dependence in their decision-making process.”
Perhaps, most telling is the market’s expectation of a rate cut is about 90%, and “the Fed rarely goes against what the market thinks they should do,” said Max Gokhman, head of asset allocation at Pacific Life Fund Advisors. “Given that we are also at the one-year anniversary of Powell's disastrous ‘a long way from neutral’ comment it's even less likely that we won't have a tail wagging the dog scenario here.”
Officials, including Fed Vice Chair Richard Clarida, repeated the Fed will "act as appropriate" to keep the expansion going in the face of "evident" risks, another sign "that a cut is all but a lock for the October meeting,” he said.
“Still, we expect the decision will not be unanimous because if we look at the data there's a case both to hold (e.g. strong beat on consumer sentiment as the labor market remains very tight) and to cut (ISM PMIs are now at the lowest level since before the crisis and September was the second straight month where we're contractionary),” Gokhman said. “The biggest question for us is whether there'll be any other announcements or adjustments to the don't-call-it-QE program of asset purchases.”
Weaker manufacturing data and increased risk to the outlook make the case for a 25 basis point “insurance” cut, according to Gary Pzegeo, head of fixed income at CIBC Private Wealth Management.
At the last meeting, three voters dissented — two looking for steady policy and one wanting a larger cut. “Based on the public statements of those and other voting members on the FOMC and developments in the global economy, we should see a similar amount of internal disagreement over policy,” Pzegeo predicted.
What’s next? “Disagreement taken together with the potential for some improvement in the trade dialogue may lead the Fed to signal a more shallow path ahead for rate cuts than the market is discounting,” he said. “We will be listening closely to the Chairman’s press conference for any signals regarding forward guidance.”
“It will be interesting to hear the Feds message about the future direction of interest rates,” according to Nick Tsafos, partner, financial services growth leader and chairman of EisnerAmper Global. “The geopolitical issues such as Brexit and the trade war between the U.S. and China, the slowdown in global manufacturing activity and the slowdown in economic activity in Europe and other developed economies posed significant risks to U.S. economy.”
But, “employment data suggests that the U.S. consumer is supporting the economy.”
While recent economic data could justify a cut, Greg McBride, chief financial analyst at Bankrate.com, said, “right now there is so much dissent within the committee that I'm not sure they could agree on where to order lunch, much less the direction of the world's largest economy, so this is going to be a closer call than we've seen in quite some time."
The post-meeting statement will not offer any hints, as the assessment of the economy will likely be “a literal 'copy and paste' from the September meeting,” and “deliberately vague so as not to paint the FOMC into any corners but also broad enough to keep their options open no matter what develops on the economic and trade fronts," he added
The manufacturing “slowdown is starting to infect the U.S. service sector, too,” said Scott Anderson, Chief Economist at Bank of the West Economics. “The ISM Manufacturing and Non-Manufacturing surveys both fell sharply last month, dropping to levels not seen since 2009 and 2012, respectively.
While hawks on the panel can brush this off as “a one-month blip ... what is harder to explain away and more troubling, in my opinion, is the sharp retreat in both survey-based and market-based inflation-expectation measures last month,” he added.
Inflation has been below the Fed’s 2% target for years, Anderson said. “The fact that inflation expectations are moving farther away from the Fed’s mandated goals suggests the central bank may still be behind the curve. This possibility bolsters the case of the doves that more accommodation will be needed to guard the Fed’s inflation mandate.”
Robert Johnson, professor of finance at Heider College of Business, Creighton University said it would be "a huge surprise" if the meeting produces anything other than a 25 basis point cut. “Given global economic conditions, I believe that a cut is warranted. The pundits who simply look at U.S. economic conditions, in my opinion, [are] misguided.”
But because of the divide on the Fed, “while this rate cut is a virtual certainty, there is no consensus on future rate cuts,” he said.
Powell is likely to “echo prior comments” on slowing global growth, the Fed’s willingness to act as needed, and the Fed’s balance sheet expansion not being quantitative easing, said Ron Alberts, director of fixed income strategies and portfolio manager at Johnson Financial Group. “Regardless of what it is called, the Fed balance sheet expansion, as well as the rate cuts, are likely to have a stimulative effect on the economy.”
The two recent “cuts have been effective, as measured by the relationship between three-month and 10-year U.S. Treasury bond yields,” he said. “Yields are beginning to normalize, with short-term yields down more than long-term yields, and a return to a positively sloped yield curve — the 10-year yield now exceeds the three-month yield. This is a favorable development for those who believe an inverted yield curve signals a recession. We expect the curve to continue to steepen following the expected cut.”
But not everyone is certain a rate cut is ahead. Mayra Rodriguez Valladares, managing principal at MRV Associates, said, “There is a good chance that the Fed will pause in rate cuts.”
“To cut rates would be a mistake,” she said. "This extraordinary decade of such low interest rates has led to a perverse incentive for company executives and private equity firms to have record levels of debt, both in bonds and loans. The rising amount of below investment grade bonds and loans could significantly amplify the effects of a recession.”
Recent bank earnings “suggest consumers and companies were active last quarter. Therefore, the economy may not need more of a boost,” said Riley Adams, senior financial analyst at Google. He said a decline in consumer confidence, and slower sales in September, suggest a rate cut would help boost the economy.