‘Patient’ Is So Passé: Full June FOMC Preview

“Financial markets and some commentators view rate cuts this year as a foregone conclusion”, Goldman wrote Friday, in their Fed preview. “And while it is a somewhat close call, we expect the Committee will prefer to keep its options open. In our view, not enough has changed to warrant a clear signal of an upcoming cut.”

To be clear, Goldman is, in fact, one of the last holdouts among the big banks when it comes to suggesting that rate cuts aren’t yet the base case. Over the last three weeks, JPMorgan, Barclays, BofA, Credit Suisse, BNP, etc. have all thrown in the towel and predicted cuts, although the expected timing varies.

The final straw for many was the Mexico tariff threat and Goldman is quick to point out that those tariffs are no longer in the cards. “The very tariffs on Mexico that prompted the latest calls for rate cuts have been taken off the table”, the bank said Friday.

Of course, in addition to the deleterious effect the imposition of tariffs on Mexican imports would have had on the US economy, the problem with the Mexico threat was that it seemed to confirm that the Trump administration no longer draws any distinction whatsoever between national security and economic/trade policy. Recall this, from SocGen:

Imposing tariffs on a country with which the US has only recently concluded a trade agreement, sets a very negative precedent in that it suggests to other countries that even if they make concessions and conclude a trade agreement, the US administration apparently does not feel bound by it. This seriously reduces the incentive for any country to negotiate with the US. Why negotiate in good faith, if the US apparently has no intention of sticking to an agreement? This could make it impossible to settle whatever trade disputes the US has with other countries. 

In other words, the read-through from Trump’s Mexico threat for trade talks with Europe and China was bad enough to further make the case for preemptive Fed cuts. When you throw in ISM printing the lowest of the Trump presidency, May’s payrolls miss, consistently cool average hourly earnings and, most recently, misses on CPI and a record-low read on U. of Michigan 5-10 year inflation expectations, you’ve got a pretty solid case for “insurance” cuts.

Still, Goldman notes that, on balance, the data is solid. “Yes, business surveys have moderated and May payrolls was a significant disappointment. But our Q2 GDP tracking estimate has rebounded to +1.6% (qoq ar, vs. Atlanta Fed GDPNow is +2.1%), our May Current Activity Indicator is running at a similar pace, and private final demand is tracking much better at +2.8%”, the bank says, adding that “it remains to be seen whether US growth will fall below potential in the back half of the year because of the trade war and related uncertainty, but outside of May payrolls, the growth data still look decent–particularly the solid rise and significant upward revisions in Friday’s retail sales report.”

(Goldman)

Subdued inflation is, of course, one of the key arguments for justifying rate cuts at a time when the unemployment rate is still sitting at a five-decade low. On that front, Goldman refers to the transitory message from the May meeting and also to the Dallas “trimmed-mean” measure, which officials have tried to emphasize.

“The Dallas Fed measure is consistent with core inflation of 1.75%, and it has also more clearly trended up in recent years”, Goldman remarks. “Furthermore, well-measured inflation (also adjusted for its average gap vs. core PCE) is consistent with above-target inflation for the first time since 2010 (of around 2.5%).”

(Goldman)

Obviously, all of these considerations have to be set against Donald Trump’s ongoing efforts to co-opt the Powell Fed in the trade war. This past week alone, Trump lashed out at the Fed at least three times, once during his wild interview with CNBC, then in a tweet about European tourism and then during his ABC interview.

In addition to generalized concerns about Fed independence, the timing of the June meeting (days ahead of the G20) makes this an especially difficult situation for the Committee to navigate, something we’ve talked about at length and discussed further on Saturday evening in “The Fed’s New Job: Financing Rationality Deficits“.

“The Committee’s goal should be to send a sufficiently dovish message to keep financial conditions in check and extend the decision about whether to cut to July”, Deutsche Bank writes, in their own preview of the June meeting. “This would provide scope to get a clearer picture about the likely path forward on any trade talks following the G20 meeting near the end of June.”

Deutsche’s official Fed call is for cuts in July, September and December. “If the Committee is unable to navigate this balancing act, and the market deems the message as insufficiently dovish, financial conditions could tighten enough to trigger a more aggressive Fed response in July”, the bank goes on to caution.

Barclays, you’ll recall, pulled forward their call for rate cuts just a week after making it. They’re sticking with that (i.e., a 50bp reduction next month and a 25bp cut in September), but the bank doesn’t think the Fed is prepared to pull the trigger in June. Their rationale centers around the G20 land mine. “We expect the Fed to stay on hold through the G20 meeting before deciding on a course of action [as] moving in advance of the G20 would likely subject the institution to unwanted political criticism”, Barclays says. “We look for the committee to signal a preference for ‘flexibility’ over ‘patience’ when assessing incoming information.”

(Barclays)

Clearly, what the Fed says (both in the statement and how Powell navigates the press conference) will determine how much leverage Trump has at the G20, especially in light of recent comments from PBoC chief Yi Gang, who made it clear that China has “tremendous” policy flexibility.

“Combined with persistent-to-deteriorating downside risks and softening data, we think [a] shift in stance will line [the Fed] up to deliver the first of our two anticipated rate cuts at its meeting on 31 July”, BNP said Thursday. The bank is looking for “three major dovish signals: 1) rising downside risks and modification of patient stance in the statement; 2) several participants projecting cuts in 2019; and 3) Powell referencing easing capacity in his press conference.”

(BNP)

As noted by BNP, most expect some members’ dots to project a cut, but whether the median moves is another matter. On the SEP, 2019’s projections will likely be marked down and in the statement, the first paragraph should reflect the less enthusiastic take on the economy.

The “patient” characterization of policy probably needs to go. The ultimate irony is that just six months ago, “patient” was a wholly dovish characterization of policy, as it marked a stark contrast with active rate hikes and passive tightening via balance sheet rundown. Now, “patient” could be construed as wholly hawkish, as it would fly in the face of market pricing and potentially derail some of the most crowded trades on the planet.

When it comes to whether “act as appropriate” / “act as needed” are, in fact, phrases that generally tip imminent policy shifts, the answer is “yes” when that language is enshrined in the statement, as long as it’s not accompanied by a caveat.

(Goldman)

The press conference has the potential to be very “interesting”, to say the least. Powell’s “plain English” approach hasn’t generally gone over well and the June meeting will be the biggest test yet of his ability to effectively communicate. On that, we’ll leave you with a list of key questions and topics via Deutsche Bank’s preview:

On the growth front, how concerned is he by recent signs of softening in US and global trade flows, manufacturing activity, and business investment spending? On the inflation front, are there still important transient elements in the current softness of inflation, or does the weakness now appear more persistent? Has inflation been low enough for long enough to warrant further easing? How much pressure does the Fed feel from strong and growing market expectations of rate cuts? (The same question could be asked (again) with respect to pressure from the Administration.) Do the market’s expectations seem puzzling or worrying? On balance sheet policy, if the Fed finds it necessary to cut rates, would it make sense also to terminate the planned balance sheet rundown early?

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