Fed hears 'loud and clear' message from bond market as it ponders next step

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With the markets expecting rate cuts to continue, the Federal Reserve will not commit to any further easing before meeting later this month.

Noting a need to remain “flexible,” Federal Reserve Bank of New York President John Williams said the Fed’s “approach has worked well recently.” Speaking to reporters following a speech at the Euromoney Inflation-Linked Products conference Wednesday, Williams said policymakers will “reassess what the appropriate stance of policy is” at the meeting.

With an employment report and other data coming prior to the Federal Open Market Committee’s Sept. 17-18 meeting, Williams said he has not decided how he will vote. Three factors he will evaluate to make a decision are the slowing global growth, muted inflation pressures and geopolitical uncertainties and how these affect the U.S. economy.

Although data have been consistent with his expectations and the U.S. economy continues to grow at an above-trend pace, he said, much could happen before the meeting. “The bond market is providing us with their perspective,” he said, adding “the message is loud and clear.”

The conference featured a panel on what the Fed will do. Joaquin de Soto, vice president of inflation trading at Goldman Sachs, said when raising rates, the Fed “probably did go a little too fast” and the “economy was not as strong as initially thought.”

The trade war’s impact on the economy has been “significant,” according to panelists, with more turns and a longer duration than was expected. As a result, the Fed must remain flexible and is probably in an adjustment cycle rather than a “full-cutting” cycle. Of course, the problem remains the Fed funds rate is much closer to zero lower bound than in previous expansions, which will make monetary policy adjustment tricky and could result in the need for quantitative easing in a downturn.

An adjustment of 75 basis points, which the market is pricing in, would be “a great outcome” since there could be a need for as much as 125 basis points of cuts. In addition to rising trade risk, the panelists pointed to the downward revision to corporate profits as a headwind, along with the possibility that a global recession is starting.

“Look at break-evens, they’re abysmal,” said Jon Hill, vice president of U.S. rates strategy at BMO Capital Markets. Those numbers aren’t consistent with the Fed meeting its objective.

Panelists suggested the Fed has been inconsistent in what they’re targeting to measure the economy. And while policymakers probably use more than one measure of inflation, no one knows if inflation is being measured correctly, given the need to account for advances in technology.

And while the Fed has ignored the political pressure being applied by President Trump, the panel believes the Fed has been acting in the economy’s best interests and has remained “as independent as possible.”

While the panel showed a divide between those who want to cut rates and those that want to raise rates, the general belief was that the Fed is trying to do what’s needed to extend the expansion.

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Monetary policy John Williams Federal Reserve Federal Reserve Bank of New York FOMC