What To Expect From The Fed At The July Meeting And Press Conference

The wait is nearly over. The Fed will almost surely cut rates in the week ahead, ushering in what many market participants hope will be an actual easing cycle, as opposed to merely a one-off “insurance” cut.

A hawkish surprise is unthinkable at this juncture. Jerome Powell made it clear at various intervals in July that recent data suggesting the US economy remains on sound footing will not deter the Fed from cutting rates this month.

The market is priced for a move, and although Powell, Vice Chair Clarida and John Williams have all extolled the virtues of moving aggressively when policy is operating near the zero lower bound, the New York Fed’s “clarification” following Williams’s speech earlier this month and the fact that Jim Bullard has stated he isn’t on board with 50bp both suggest the first cut will not “be the deepest”, so to speak.

Read more: Fed Officials Succeed In Thoroughly Confusing Markets Just In Time For Pre-Meeting Blackout

“Our view remains that 25bp is much more likely because virtually all of the signals from the committee point that way”, Goldman writes, in their July FOMC preview, before running through recent communications as follows:

First, the headline of an article by the well-connected Nick Timiraos of the Wall Street Journal stated baldly that “Fed Officials Signal Quarter-Point Cut Likely at July Meeting.” This followed on the heels of an unusual statement by the New York Fed that the market interpretation of a speech by President John Williams as providing a signal for 50bp was mistaken. Our read is that while the Fed leadership has refused to answer the 25bp vs. 50bp question publicly, it leans privately toward the 25bp camp. Second, we see little support for a 50bp move among other FOMC participants. Even at the dovish end of the spectrum, only Minneapolis Fed President Kashkari has made an affirmative case for 50bp, and that was before the recent run of strong data. Chicago Fed President Evans said more recently that “there is an argument” for 50bp, but stopped short of urging such a step. And St. Louis Fed President Bullard, who dissented in June in favor of a 25bp cut, reiterated his view that 50bp would be too aggressive in an interview.

Goldman also thinks the Fed will announce that balance sheet rundown will end this month. Obviously, it makes little sense to ease with one hand and tighten with the other, but as Barclays points out, “the committee has already signaled its intent to end the reduction in securities holdings in September [so] members are not likely to see an earlier end to balance sheet normalization as adding much value at this stage”. BofA thinks it’s a close call, but ultimately says balance sheet reduction will end after July “to achieve a signaling effect”. BNP agrees.

Obviously, the economic case for rate cuts from the Fed has not strengthened since the June meeting. Goldman – the bank that held out the longest when it came to adopting rate cuts as the base line – doesn’t mince words. “We were unconvinced of the need for easier policy even at the time of the June 18-19 FOMC meeting, and virtually all of the information since then has come in on the stronger side”, the bank rather dryly notes, in the course of running through the evidence:

President Trump postponed the threatened tariff escalation versus China, all of the major economic reports– including payrolls, retail sales, the manufacturing surveys, core CPI, and UMich 5-10 year inflation expectations–have surprised on the upside, and financial conditions have eased further since the meeting. 

“The challenge for Chairman Powell will be to explain why the Fed is cutting given the recent run of stronger data, and the primary risk, in our view, is that markets will interpret the message that further rate cuts are data dependent as hawkish”, Deutsche Bank cautions.

Friday’s advance read on Q2 GDP doesn’t really help make the case either, although the Fed could point to weakness in exports and business spending as well as still subdued inflation as giving the committee some scope to squeeze in a cut without risking an overheat.

“Altogether, the data seem to confirm our view — and the Fed’s view — that weaker growth outside the US, fading fiscal stimulus, elevated trade policy uncertainty, and past monetary tightening is weighing on industrial activity and business confidence”, Barclays said Friday, adding that “while headline GDP growth is not too different from what the Fed expected in the first six months of 2019, the composition of growth is likely to be worrisome to many FOMC members”.

The real question is whether the statement (and, subsequently, Jerome Powell’s press conference) manage to convince market participants that the door is open to an actual easing cycle as opposed to a cut in July, another in September, and then done. That is, market participants will be looking for a reasonably open-ended commitment to accommodation.

“We expect the phrase ‘act as appropriate’ to remain in the July statement as an indication that the committee’s baseline is a second cut at the September meeting”, Goldman says, after reiterating that while a September cut is “far from a done deal”, it’s still the bank’s base case. “Barring a worsening in the outlook by September, we would expect a second cut at that point to be accompanied by an indication that the committee views a 50bp recalibration as sufficient for the time being”, they add. Here is Goldman’s mock statement:

(Goldman)

Note Goldman expects a dissent from Esther George. BofA talks quite a bit about dissents in their preview of this week’s proceedings. “We see a possibility for a few hawkish dissents including Rosengren (very likely), George (likely) and Quarles (possible)”, the bank says. That potentially means Powell will have to come across as even more forcefully dovish in the press conference in order to counter the signal from prospective dissents.

If you ask BofA, there are a couple of options for Powell to “prove” how committed he is to a dovish bent. To wit, from the bank:

He can take a page out of the Draghi playbook by hinting at ‘whatever it takes’ In this regard, he may state that the Fed will continue to cut rates and use their tools as appropriate to make sure that the recovery continues and that the symmetric 2% target is met. He could note that today’s rate cut is just the first step in the Fed’s attempt to underpin the expansion. This would be an aggressive counter to the hawkish dissenters. 

For what it’s worth, dissents do matter for S&P returns and that’s likely to be especially true this time around considering how important it is for the Fed to “keep the dream alive” (to quote Nomura’s Charlie McElligott).

Drawing on the extant literature, BofA notes that if one looks at “a 30 minute window (1:50pm — 2:20pm) and a 60 minute window (1:45pm — 2:45pm) around the 2:00pm press statement release… stock prices typically declined if there were dissents; while stock prices typically increased if there were no dissents”.

(BofA, from “The effect of FOMC votes on financial markets”, Carlos and Joao Madeira)

If you ask BNP, the hawkish risk is that the Committee upgrades its effective balance of risk assessment “due to the lower fed funds rate, which would signal less appetite for further cuts than leaving the effective balance of risks assessment (in this case, uncertainties about the outlook) unchanged”. In their preview, the bank goes on to say that “while Powell has largely dismissed the relatively strong run of June data to this point, any marginal acknowledgment of it in his press conference would also likely be interpreted as somewhat hawkish”.

All told, this will be a delicate balancing act.

And, of course, the orange man in the White House will be watching closely. Any communications “misstep” by the Fed that leads to a spike in the dollar or a decline in the S&P risks eliciting an irritated response from the man who has variously insisted that Powell “doesn’t have a clue”.