The Federal Open Market Committee meeting will culminate Wednesday with the release of a new Summary of Economic Projections, providing a better clue as to whether the expected rate cut is part of a mid-cycle adjustment or the second step in an easing cycle.
Developments over the weekend in the Middle East should not change the expected outcome: a 25 basis point rate cut.
“I do not think the situation in Saudi Arabia changes anything for the Fed,” said Brian Rehling, co-head of global fixed income strategy for Wells Fargo Investment Institute, after an attack on a processing center knocked out about half of Saudi Arabia's oil output capacity, prompting the Trump administration to blame Iran and call for a response by U.S. allies.
“Longer term, if it hurts Europe and developed markets, then perhaps global uncertainties remain elevated and could lead to weaker global growth and ultimately lower rates," Rehling said. "But that is stringing things together and likely not relevant in the near term.”
While Rehling expects a rate cut at the meeting, he expects the markets will be “a little disappointed” in the long term. The Fed has “to be pretty judicious” so it has some ammunition left if the economy goes into recession. And while it’s “almost impossible to predict” what would spark a recession,” a downturn is “not a foregone conclusion.”
“Even though everyone expects the data to start softening, it hasn’t yet,” he said. And the Fed hasn’t done a good job of “messaging what their guiding light is. They don’t appear that data-dependent anymore. It seems they’re being pushed around by the markets. They can’t let the markets do that,” Rehling said.
“With the Fed concerned about geopolitical risks, mainly with the trade war, we will see greater calls for them to switch to an easing cycle,” said Edward Moya, senior market analyst, New York at OANDA. “The situation will remain tense in the Persian Gulf and that may have been the straw that broke Powell's mid-cycle adjustment back.”
A 25 basis point cut strikes “a fine balance” for an economy doing well with trade tensions easing but global economic weakness, said Yohay Elam, currency analyst at FXStreet. “Fed Chair Jerome Powell would probably like to alleviate market concerns without being seen as surrendering to them.”
Elam will watch for “potential surprises,” including the post-meeting statement “dropping words such as ‘strong’ or ‘solid’ from the characterization of the labor market,” which could signal the panel is worrying more about recession. “On the other hand, if Powell and his colleagues upgrade their language regarding inflation — not describing it as subdued anymore — stocks may fall, as the chances of further cuts will have dropped.”
While most expect the quarter-point cut, economist and Mises Institute fellow Ryan McMaken suggested the FOMC “may even surprise us by leaving rates unchanged.” He discounted a 50 basis point cut because "The Powell Fed has not shown much inclination toward any big moves in policy.”
He added, “I don't think a recession is imminent, but continued weakening and slowing may indeed be the name of the game for 2020, and the Fed may be afraid of this."
“Investor expectations are very high,” according to Jameel Ahmad, global head of currency strategy and market research at FXTM, “this is not necessarily a positive thing.”
Trade is the central issue for policymakers. “I will not rule out the Federal Reserve holding back from further interest rate cuts until clearer indications come through that the global economic slowdown elsewhere is creeping into U.S. data,” Ahmad added.
While a quarter-point cut is expected and likely, a small chance remains for a 50 basis point cut, said Gary Pzegeo, head of fixed income at CIBC Private Wealth Management. A reduction in the fed funds rate target would bring it to a 1.75% to 2% range, lower than the median projection in the June dot plot, so it “will have to shift lower.”
The last SEP “was close to evenly split between a group of 8 policy doves and 8 in favor of the status quo (1 voter expected a hike would be necessary),” he said. “With stubbornly low inflation, weaker manufacturing data, markedly lower yields, and the lingering threat of trade policy clouding the economic outlook it would not be surprising to see the median dot drop by 2 to 3 cuts in 2019 and 2020.”
The dot plot holds the interest for this meeting. “It will be interesting to see how many Committee participants see additional easing as likely to be appropriate, and markets may react to that information,” said Bill English, a professor at Yale School of Management. “Of course, other participants, including those who have disagreed with the policy easing this year, will presumably judge that an increase in rates will be appropriate fairly soon.”
Market participants should also keep an eye on the long-run rate projection. “The Committee has gradually moved the longer-run level of the funds rate lower in recent years, and it was down to 2.5% in June. If it moves down again, perhaps to 2.3%, that would signal a lower path for interest rates even over the longer term.”
“Broadly, the committee will want to keep its collective options open beyond the September meeting,” said Mark Hamrick, senior economic analyst at Bankrate.com. “As recently as the June meeting when it last released the set of economic projections, the FOMC did not indicate an expectation that rates would be cut this year. The updated dot plot will reflect the subsequent change of heart while signaling flexibility for the months to come given that trade tensions and tariffs remain a source of uncertainty for business, generating headwinds for the economy.”
Despite improvement in the trade situation and Brexit, “Fed Chair Powell is still looking at an unsettled landscape,” said Dec Mullarkey, a managing director at SLC Management. “The recent U.S. manufacturing contraction is now confirming the weakness that the rest of global manufacturing has telegraphed for months. The chief culprit is trade tension as it pinches factory output.”
And while these fears cause businesses to “pull back on capital expenditures,” if it cuts into hiring or hours worked, it could hit consumer confidence, which is already “beginning to slip from its previously elevated levels.”
The markets will look at the dot plot, but its “market relevance … has faded,” as markets look for “any member shifts to the dovish camp,” which would make participants “feel confident that expectations for 100 basis points in cuts over the next year look more accurate.”
Tony Bedikian, head of global markets at Citizens Bank, said the key in the statement will be “any changes to the acknowledgment of risks around global weakness and/or tariff war.”
In terms of fundamentals, Fed policy is tight, said Ed Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle. The “real fed funds is roughly still in line with median estimates of the neutral rate … the yield curve is flat to inverted, and the U.S. dollar has strengthened despite a significant change in the Fed’s posture since last December. ... These are all consistent with more easing and the probability of cutting fed funds by 200bp to avoid a recession/engineer a soft landing in 2020. This is underpriced by markets.”
The Fed could change direction and “put a higher priority on the financial stability risks from further easing” or become “more conservative in terms of its inflation outlook (we will need to see growth and inflation surprise FOMC forecasts to the upside over the next 6-12 months for this change),” Al-Hussainy said.
“The escalating trade war is forcing the hand of Jerome Powell and the Federal Reserve Board of Governors to comply with the president’s wishes,” said Robert Johnson, chairman and CEO at Economic Index Associates. “Absent the trade situation, I believe that there would be very little chance for the U.S. economy to experience a recession in the near term.”
And while the “yield curve briefly inverted,” which many market watchers believe infers “a recession is imminent,” Johnson said, “While certainly troubling, a temporarily inverted yield curve is not an automatic harbinger of a recession.”
