At its June FOMC meeting, the US Federal Reserve left the target for the fed funds rate at 2.25-2.50%, but signalled that rate cuts are likely by year-end. We expect 50bp of cuts in 2019.
What a difference six months make. On 19 December, at its final meeting of 2018, the Federal Open Markets Committee (FOMC) raised the target range for the federal funds rate to 2.25-2.50%. It was the ninth rise in a cycle that began three years earlier in December 2015. At that time, it was not expected to be the last rate increase as the FOMC indicated that it intended to proceed with "some further gradual adjustment in policy rates."
FOMC: Pivoting from higher rates to rate cuts
In January 2019, after an extension of the 2018 Q4 slump in risk asset valuations, the Federal Reserve (the Fed) adjusted its communication, removing the reference to “some further gradual adjustment” from its policy statement and indicating that it was putting rates on hold. The 2019 Fed 'pivot' had begun.
At the FOMC meeting on 19 June, the pivot was extended toward rate cuts. Unless there is a sudden deluge of good economic news, our research team now expects at least 50bp of rate cuts this year. While the exact timing of the anticipated cuts will depend on incoming data and other events, the first 25bp rate cut is expected at the FOMC’s July 30-31 meeting.
Exhibit 1: Following nine rate increases since December 2015 taking the fed funds rate to 2.25-2.50%, the US Federal Reserve is now pivoting toward rate cuts
(Graph shows changes in the fed funds rate, 2007 – 2019)
The Fed is for turning...
Various changes in the FOMC statement were clearly designed to put the market on notice that action is likely. At May's meeting, we were told:
“In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes”
Patience has, however, now been exhausted:
“The Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.”
It's not obvious how the Fed could have been more dovish in June...
Meanwhile, the Fed's main communication mechanism for the likely path of monetary policy, the 'dot plot', shows a dramatic move in a dovish direction (more cuts in rates) since the dots were last published in March. There has been a significant shift on the FOMC with seven members (that is half the FOMC) now expecting two rate cuts between now and the end of 2019. In short, this is about as dovish as the Fed could possibly have been without lowering rates.
Apart from the continued undershooting of inflation, news on the real economic conditions are not bad...
Curiously, if one turns to the macroeconomic projections that sit alongside the policy dots, there is little to see. Growth was revised up for 2020, but otherwise unchanged relative to the March forecasts. The unemployment rate profile was revised lower for 2019, 2020 and 2021. So on the real side of the economy, it is if anything good news, although that impression is somewhat tempered by the downgrade to language on growth in the statement (from “solid” to “moderate”).
Admittedly, on the inflation front, the projections are significantly lower: in 2019, the median Fed forecast for the measure targeted by the Fed, the personal consomption expenditure (PCE) index is 30bp lower at 1.5% from 1.8% (Q4/Q4). The PCE index has risen only 1,5% annually since the financial crisis. In June the Fed forecast it will not reach the targeted rate of 2% until at least 2021.
At the news conference, Chair Powell commented in passing that wage growth is currently consistent with delivering inflation at the Fed's target. So we have something of a conundrum.
This is further confirmation (as if any were needed) that G7 bond markets are in a low-inflation, low-yields-for-a-long-time environment.
June's FOMC meeting also confirms that the environment since the Global Financial Crisis of 2007-2008 is vastly different to what went before.
A Fed rate rise cycle now ends with the fed funds rate at 2.5%. It would seem that the patterns that existed between 1945 and 2007 tell us little or nothing about what has happened in the years since.
In the short term (i.e. through to the end of 2019), 'Goldilock' conditions, with growth strong enough to offer hope and inflation conspicuously absent, look set to continue.
G7 bond markets are in the thrall of disinflation/deflationary forces - vulnerable to any sign of inflation - but intrepid in the knowledge that none has been forthcoming despite years of non-conventional central bank policy measures.
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