Powell testimony reinforces expectation of a rate cut
Federal Reserve Board Chairman Jerome Powell suggested he sees an increase in uncertainty, which market observers interpreted as a signal that a 25 basis point rate cut is coming, despite his assertions that the economy is strong.
At the last Federal Open Market Committee meeting, “many … participants saw that the case for a somewhat more accommodative monetary policy stance had strengthened,” Powell said in prepared testimony released by the Fed on Wednesday. “Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.”
The minutes from the June 18-19 meeting, released Wednesday, showed “Many judged additional monetary policy accommodation would be warranted in the near term should these recent developments prove to be sustained and continue to weigh on the economic outlook.’’
Speaking before the House Financial Services Committee, Powell said the Fed’s baseline outlook still assumes solid economic growth, strong labor markets, and inflation rising “over time to the Committee's 2% objective.” He also said “crosscurrents, such as trade tensions and concerns about global growth, have been weighing on economic activity and the outlook.”
Was he suggesting the Fed will make an “insurance” cut at its next meeting?
“I interpreted Powell’s testimony as somewhat dovish and expect a 25 basis point reduction in rates at the July 31 FOMC meeting,” said Arthur Bass, managing director of fixed income financing, futures and rates at Wedbush. “The testimony comments on the decline in [personal consumption expenditures] from close to 2% last year to close to 1.5% in May.”
He added, markets are pricing in a rate cut this month and 75 basis points of cuts through the Jan. 29, 2020, meeting.
“One potential issue for the July meeting is interest on excess reserves (IOER),” Bass added. “Fed funds effective has been 6-7bp above the 2.35% IOER level the past week, which is leading some to question whether there could be another ‘tweak’ in IOER.”
With the markets expecting a July easing, Powell “did nothing to dissuade markets,” said Payden & Rygel Chief Economist Jeffrey Cleveland. “Risks to the U.S. economic outlook have increased, with global trade tensions bleeding through into confidence measures and other economic indicators, he argues. Meanwhile, there is no inflation pressure. The FOMC thought risks would diminish and inflation would perk up but instead global economic risks have intensified since May and inflation remains soft. Why not err on the side of sustaining the economic expansion and cut?”
While Payden & Rygel sees expansion continuing, Cleveland said, it’s important to note an “insurance” cut “would arise not from concerns about a more severe economic slowdown and could even bolster our case as monetary policy and financial conditions would remain even easier for longer.”
Stifel Chief Economist Lindsey Piegza still doubts a rate cut is a given, and says Powell “walk[s] a fine line” in citing “the perceived risks to the outlook and the market’s demand for action, while reiterating relative confidence in the current state of the economy.”
Powell is sending a “more tempered, patient message” that the market is missing, Piegza said. “The market could be poised for a severe disappointment come July,” she said. “Some media outlets have written up the upcoming policy decision as a choice between 25bps or 50bps, overlooking the fact that a rate cut itself remains the primary debate.”
Responding to questions, Powell said, “The economy is in a good place and we will use our tools to keep it there.” He later said the panel doesn’t foresee “a severe downturn.”
The strong June employment report did not push the FOMC to a decision, Powell said, adding that policymakers “look at a broad range of data,” with key growth, inflation and employment data still coming before the meeting. And while data in this country has come in “about as expected,” numbers from the rest of the world “continue to disappoint.”
Wholesale inventories grew 0.4% in May while wholesale sales rose 0.1%, the Commerce Department reported Wednesday.