The latest Summary of Economic Projections, and statements by Federal Reserve officials, show a nearly even split between those favoring a rate cut and those opposed.
While the governors are all likely to back a rate cut, as will most of the regional Bank presidents with votes this year on the Federal Open Market Committee, there will likely be some dissent.
“It does seem that there are intellectual dividing lines at the Fed,” said Bruce Monrad, chairman of Northeast Investors Trust. “It’s interesting that [Federal Reserve Board Chair Jerome] Powell changed his tune on the neutral real rate a few months after [John] Williams took over the New York Fed, given that Williams penned the seminal argument about the falling neutral rate. It’s also interesting that [Dallas Fed President Robert] Kaplan is raising the issue of the costs of lower for longer, since he historically worried about the shape of the yield curve.”
Such is the case among Fed watchers too: some see a cut as beneficial, while the others don’t see the need.
A “common mistake investors make [is] thinking of the Fed as an ‘it’ rather than a ‘they,’” said Payden & Rygel Chief Economist Jeffrey Cleveland. “They all have somewhat different views, particularly at key turning points. I doubt there is a consensus view among policymakers right now. As a result, we may see a dissent or two at this meeting (e.g., [Federal Reserve Bank of Boston President Eric] Rosengren).”
Despite issues including trade, tariffs and Brexit, Cleveland said, “the U.S. economy is nowhere near as weak as some investors suggest (and certainly not weak enough to justify 3-4 rate cuts over the next year).”
Bond investors “like low and stable inflation,” he said. “It seems likely the Fed will cut, but should they?”
The Fed has repeated it will be “data dependent,” said Stephen Taddie, managing partner at Stellar Capital Management. “Recent U.S. economic data supports a continued pause, rather than a cut. That said, the Fed may have over-communicated themselves into a corner, much like the position they were in last December, prior to the rate increase.”
But trade issues have made it “tricky” to determine if trends are transitory, he said. And with the economy “chugging along despite volatile trade negotiations” it’s possible “the slowdown evident earlier in the year may end up being both shallow and temporary,” Taddie said. “I do not believe it is critical for the economy that the Fed cuts rates at this meeting.”
In a recent Bond Buyer podcast, Mickey Levy, Berenberg Capital Markets Chief Economist U.S., Americas and Asia, said he doesn’t believe a rate cut will spur the economy. “The factors that are inhibiting growth now have everything to do with trade and global tensions and
While economic fundamentals remain “solid,” Greg McBride, senior vice president and chief financial analyst at Bankrate, said, “the Fed is concerned about the 'cross currents' — to use their term — of trade disputes and slower global growth and will use an interest rate cut as a bit of preventative medicine."
Markets are pricing in more than one rate cut before the year ends, McBride said, “and while the Fed will indicate a willingness to further support the economy as needed, additional action is far from guaranteed. But if the Fed continues to ignore economic fundamentals and kowtow to the stock market and the White House, the risk of inflating an asset bubble becomes very real."
While concern over inflation that still doesn’t meet the Fed 2% target and a desire to keep the expansion going will be the explanation for a cut, Jonathan Rigano, portfolio manager at RMB Capital, said “we also anticipate there will be a number of dissents outlining economic factors (such as the current unemployment rate, which is well below its projected long-term level) that do not indicate a cut is necessary at this time.”
Those opposing a cut will argue “that the economy has simply been slowing to a more sustainable level of growth.”
To be sure, some economists see “red flags.” Scott Anderson, chief economist at Bank of the West, pointed to the Conference Board’s Leading Economic Index, which in June, "dropped the most in one month since January 2016, which was the last time the U.S. economy was struggling to grow and business investment was in a technical recession.”
And trade issues will get worse, and will impact manufacturing first. “We also believe what starts in the manufacturing sector won’t stay in manufacturing sector; it will eventually spill over into the service and technology sectors as well,” he said.
“Since monetary policy works with a lag of about six months to a year in the best of times, the Fed needs to look beyond the next month or two and try to divine where the economy could be six months to a year from now without any additional monetary support,” Anderson said. “We think the choice is clear, now is the time for the FOMC to cut rates, if there is any chance to stave off a sharp slowdown or outright recession next year.”
According to Gary Pzegeo, head of fixed income at CIBC Private Wealth Management, “trade uncertainty, falling inflation expectations, and risk to the domestic economy provided enough justification for Powell and the Fed to deliver the dovish message demanded by the market (and others) at the June meeting.”
Since then, he said, “trade uncertainty became slightly less uncertain, inflation and inflation expectations rose, and the data has improved. But it is not enough. The Fed will likely follow through with an insurance policy cut or two for the market over the rest of the year.”
The markets expect three cuts this year and more next, which would seem less like insurance and “more like a response to recession.” Such cuts are unlikely and “may require the Fed to manage market expectations,” he said.
What to watch
With a rate cut all but assured, “it will be interesting to see how they frame the communication,” said Ryan McQuilkin, head of fixed income at Boston Private. Recent data suggest “a mostly stable economy, but will the Fed still focus on potential weakness and downside risks?”
A rate cut with a strong economy “may imply that the Fed will also be more proactive in the future,” he added. “Ultimately, it is unclear whether the market will view this favorably, as policy decisions that prove to be incorrect or over-reactive could damage their credibility.”
Steven Oh, PineBridge global head of credit and fixed income, sees two rate cuts in the next 12 months. “Barring a material flare up in trade matters, U.S. rates should be somewhat higher as the market is pricing in more stimulus and a greater bearish outlook than currently justified by fundamental economic conditions,” he said. “The swing factor could be the magnitude of ECB actions and the potential for it to pull down rates, including that of the U.S., through its forthcoming policy actions.”
He said, “the bond market should remain range-bound.”
Fed watchers will look for clues whether this cut will be a one-and-done or the start of an easing cycle.
“With the market pricing in greater than a 50% chance of three or more cuts this year, both the market and the Fed have signaled a wide range of potential outcomes,” said Brian Pirri, principal at New England Investment & Retirement Group. “We will be listening closely for any change in tone and looking forward to expectations for their September and October meetings.”
50 bps?
“I would be surprised, given recent economic data if Fed chose to cut rates by 50 basis points at the meeting this month,” said Robert Johnson, chairman and CEO at Economic Index Associates. And should the cut not materialize, it “would roil the markets.”
