13 Jun 2019
Will Chair Powell promise everything and nothing?
The Federal Open Market Committee (FOMC) meets next week, with its policy decision due at 19:00 (UK time) on Wednesday 19 June, published alongside its forecasts and followed with Chair Jerome Powell delivering his post-meeting press conference at 19:30.
The meeting comes on the back of a period of heightened speculation that the Federal Reserve is gearing up to loosen the stance of policy. At the time of writing, the Fed funds futures strip implied investors were expecting more than two 25bp reductions in the target range before year end, with speculation seemingly centred on when rather than if the next move would occur. In terms of next week’s decision, we expect the FOMC to announce one of ‘no change’ with the target range held at 2.25-2.50%. This also appears to be the expectation within interest rate markets, where a full 25bp reduction in rates is not priced until a later meeting, albeit as soon as July.
The heightened expectation of Federal Reserve policy easing ahead has come amidst further grandstanding from President Trump on trade talks, exaggerated by taking Mexico to task on the need to address migration issues with the threat of tariffs on all Mexican imports into the US (subsequently this has been sorted out). However speculation has also been enhanced by concerns that US-China relations might be on a slippery slope, with differences spreading beyond the trade policy space and into the commercial policy sphere. Coupled with a scattering of softer data points (a just 75k non-farm payroll gain in May) and talk of inflation being low, this has enhanced bets of forthcoming Fed rate cuts. Such talk has also been supported by some Fed participant comments, not least from FOMC voting member James Bullard of the St Louis Fed, who at the start of June said that rate cuts might soon be warranted.
Fed Chair Powell gave a more guarded assessment of the implications of trade developments on 4 June when he said we “are closely monitoring the implications of these [trade] developments for the U.S. economic outlook” and that “as always, we will act as appropriate to sustain the expansion”. Investors took this as a further hint that more policy easing might be on the way, though one could argue that Chair Powell’s statement was nothing more than one might have expected from the Fed chief, who had no choice but to show an awareness of market interest rate bets and trade developments, whilst the comment on Fed action looks to us to be aimed to reassure, without promise of any specific action.
We consider that over the past month the chance of Fed rate reductions has increased and that the balance of risks are titled in that direction. But we do not judge at this point that cuts will be forthcoming this year, barring a further clear deterioration in trade relations with China (and perhaps others, such as the EU too). We are nervous about this view, given that short term market interest rate expectations are rarely very wrong, and our view of steady policy is clearly at odds with market pricing, but we do not judge that the case is made for rate reductions. Our reasoning is as follows.
We do not at this stage judge that US-China trade relations are on a continually sliding slope. Whilst we consider that it may take further time for the US and China to come to a resolution, we do judge that both sides, and particularly the Chinese authorities, will eventually look to find compromise. For President Trump, this may not be immediate amidst gains in his approval rating as he talks the talk on trade. However he will not wish to see a precipitous fall in stocks nor apply a material squeeze to economic momentum, so we judge that there will be a brake applied to President Trump’s willingness to play hard ball. Chair Powell, will nevertheless no doubt be considering, faced with severe downside risks should trade relations sour further, whether a case should be made for a precautionary rate cut. On this subject, we note that Federal Reserve Board Vice-Chair Richard Clarida has flagged in recent comments, the 1998 example when the FOMC did just this. The record of the conference call (21 September 1998) held prior to the meeting at which policy easing was decided upon, highlights that the subsequent rate cuts were made in the face of a solid domestic economic backdrop but amidst global worries in the midst of the Asian Financial Crisis. Importantly though, one lesson following the 1998 rate reductions was that the domestic backdrop soon after forced a tightening as rising inflation worries spurred the Fed into 175bps tightening in the year from June 1999 to May 2000.
Considering the domestic economic backdrop, we do not judge that this is screaming for a rate reduction. US economic growth looks set to slow materially in Q2, but this is coming off the back of a robust 3.1% (saar) Q1 growth pace. Furthermore, we are wary of taking magnitudinal steers from softer recent survey data releases; these may well be subject to ‘big event’ distortions such as on the trade front. On the jobs market, we are keen to see more data on non-farm payroll gains given the volatility of these numbers month-to-month. The headline unemployment rate stands down at 3.6%, its lowest level since 1969 whilst the wider ‘U6’ unemployment measure paints an even clearer picture of the lack of spare capacity in the labour market, down at 7.1%, the lowest since December 2000. Furthermore, the most recent Beige Book was scattered with references to the tight labour market. For the FOMC, whilst pay growth remains contained for now, we would imagine such metrics would be a reminder of the possible pay growth pressures ahead, when weighing up the need for ‘precautionary’ rate cuts.