Policy Pivot Underway: Heralded as the most important meeting of the year, the FOMC was fully expected to cut the Fed Funds rate for the first time since October 2008. In direct opposition to the negative outcomes triggered by hawkish concern this past December, the ~10% rally we’ve seen in the S&P 500 since the early-June lows has been driven almost entirely by a dovish shift in global monetary policy messaging. Although the futures market had signaled a ~20% chance of rates being reduced by 50 bps, the more tempered 25 bps “insurance cut” that was delivered was clearly the consensus view.
The FOMC’s vote to reduce the target range for the Fed Funds rate to 2.00% to 2.25% was not unanimous, with Ester George (Kansas City) and Eric Rosengren (Boston) both voting to take no action. Notably, the quantitative tightening policy that has allowed the Fed’s balance sheet to contract by up to $50 billion/month is now finished (two months earlier than previously indicated). By removing this source of bond supply, markets should be in a better position to absorb deficit-related issuance.
Decoding the Message: The official statement continues to indicate that “economic activity has been rising at a moderate rate.” Recently reported 2Q-19 real GDP of 2.1% exceeded most expectations. Consistent with recent payroll reports, “job gains have been solid.” With 105 consecutive months of payroll expansion, the official unemployment rate was at 3.7% in June. That said, wage growth has not yet induced inflationary pressures, and the statement noted how “market-based measures of inflation compensation remain low.” The Fed’s preferred measure (Core PCE) was at 1.6% in June and is below the symmetric 2.0% target. The Committee maintained language suggesting that it would “act as appropriate to sustain the expansion” amid “uncertainties” to its most likely outcome. Specifically noted were weaker global growth (Europe & China), the impact of trade tensions on business investment, and the potential harm these could have on overall confidence levels.
In Chairman Jerome Powell’s press conference, he indicated how this action was viewed as an exercise in “risk management.” Without evidence of “booming” in the economy, they don’t see any reason not to attempt to keep the cycle going via a mid-cycle adjustment. Benefits finally accruing to lower-income parts of the population were again cited as key.
Market Reaction: Post-meeting, the Fed Funds futures are pricing in a >75% chance of at least two more cuts over the next 12-months. This outcome would be similar to what took place in the second half of 1998, when then Chairman Alan Greenspan led a 75 bps easing campaign, before having to reverse course in mid-1999 as the return of “irrational exuberance” had moved stocks ~30% higher. That cycle ultimately concluded with a difficult bear market, as by late 2002 the S&P 500 was ~25%lower than when policy intervention began. Today’s market response to the official statement and the press conference seems to have come up a little short of expectations, with stocks trading down and the US Treasury yield curve flattening.
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