In line with market expectations, the Federal Reserve Board cut the Fed Funds rate by 25 basis points during their October meeting. This was the third rate cut since July, reducing the Fed Funds Rate 75 basis points since the beginning of the year. Prior to the meeting, various Fed members cited weaker economic data as well as outside risks to the outlook including the US-China trade war and Brexit. Negative developments in these outside risks could be supportive of a more accommodative policy. Importantly, the Fed dropped the statement that it will “act as appropriate to sustain the expansion.” It did however signal that additional cuts will be dependent upon future data releases and that as additional data comes in they will, “assess the appropriate path of the target range for the federal funds rate.”
The Fed will continue to be data dependent with a focus on manufacturing and business data especially. However, Chairman Powell made it clear the current state of monetary policy is, “likely to remain appropriate.” Markets now do not expect the next rate cut until well into 2020, with those expectations having been dialed back over the last few weeks as the bar for additional cuts has been raised higher. Trade negotiations will continue to be very important to the Fed, but tensions have been easing as we appear to approach the signing of a phase one China deal. The positive trade developments along with progress on Brexit could make the Fed hesitant to ease further as uncertainty is removed from the global economy.
In addition to monitoring the data, we intend to closely watch speeches by various Fed members over the coming months for signals on monetary policy going forward. The Fed’s current dot plot – intended to convey the members’ interest rate expectations – are higher than rates implied by Fed fund futures suggesting the market has a more bearish view on the economy than the committee. However, there is significant dispersion in the dots, displaying the differing views within the Fed. The growing rift within the Fed suggests a more flexible approach but also risks confusion in communicating monetary policy to the market, a potential recipe for heightened market volatility.
We continue to believe the U.S. economy will withstand this temporary slowdown, especially considering the Fed’s willingness to extend the cycle. Though the statement today was more balanced than previous meetings and we still believe the Fed stands ready to act as needed if data deteriorates, Powell made it clear it would take a substantial change to their outlook to merit another cut. Should growth fall further, the Fed still has plenty of scope to cut further, re-anchor forward expectations and prop up economic growth. In our base case of growth stabilization we would expect the Fed to remain on hold but skewed dovish, especially with inflation a secondary concern. For these reasons, we believe monetary policy should continue to be supportive of our equity overweight and preference for U.S. equities.
Originally Posted on October 30, 2019 – Fed Issues Third Rate Cut Of 2019
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