It’s safe to say Jerome Powell is not looking forward to this week.
The odds of a 50bp cut at the September FOMC are very low, which means the chances of the Fed coming under fire from the presidential Twitter account are extremely high.
Donald Trump spent quite a bit of time last week lambasting Powell and his colleagues, going so far as to call them “boneheads” and demanding they “get our interest rates down to ZERO, or less” so Steve Mnuchin can start “refinancing our debt”.
Read more: Trump Demands Negative Rates, Calls Jay Powell, Fed ‘Boneheads’ In Wild Screed
“Unfortunately”, the data continues to hold up reasonably well, although the contraction-territory ISM manufacturing print, slumping consumer sentiment and persistent uncertainty around trade should be more than enough to “justify” the expected 25bp cut. (Remember, “justify” is now a relative term – there is no real justification for cutting rates – it’s all contextual.)
Here’s how the data and financial conditions have evolved:
(Goldman)
It’s true that voters are starting to fret about a recession and it’s clear that overall activity is likely to decelerate further from there, but with retail sales still firm, the labor market performing reasonably well (August was a miss, but it wasn’t egregious), core inflation rising and the services sector still holding up, it’s very difficult to make the case for a 50bp move at this week’s meeting.
Nothing in Jerome Powell’s Jackson Hole speech or his remarks in Zurich suggested the Fed is prepared to totally abandon the “mid-cycle adjustment” characterization of rate cuts in favor a Trump-friendly, market-pleasing nod to a prolonged, aggressive easing cycle.
There have, of course, been all manner of tariff escalations and accompanying market volatility. Ironically, that might make the Fed even less likely to countenance aggressive accommodation.
Remember, Trump escalated the trade war the day after the July FOMC, a laughably transparent attempt to “punish” the Fed for not telegraphing more easing. In short, Trump broke the Osaka truce out of sheer spite for Powell after the Fed chair’s disastrous press conference, setting in motion a series of events including, but not limited to, China letting the yuan breach the psychologically important 7 handle, long-end yields collapsing, the 2s10s inverting and US equities gyrating wildly in thin summer markets.
The Fed is doubtlessly aware that Trump is attempting to engineer rate cuts by stoking uncertainty, something the committee wants to avoid like the plague. Meanwhile, Trump’s explicit calls for rate cuts only make the Fed more wary of getting co-opted into the political calculus.
That said, with the dollar resilient and the US economy still the “cleanest dirty shirt” (in fact, you might even call it a clean shirt in a filthy pile), the US risks importing disinflation in the absence of aggressive Fed cuts. That will factor into the Fed’s decision calculus.
Read more: Recession Or No, The Fed Has To Cut Rates Aggressively
“In light of the limited changes in the data since July, the FOMC statement is likely to change very little”, Goldman writes, in their FOMC preview, adding that “the statement will likely retain the pledge to ‘act as appropriate’, a phrase that has appeared in recent speeches by the Fed leadership, but will likely again draw hawkish dissents from Presidents George and Rosengren”.
Considering recent comments to Reuters, it’s possible Bullard will dissent in favor of a 50bp move.
Goldman doesn’t expect much in the way of dramatic changes to the SEP. The bank does think next year’s inflation projections could rise by a tenth. “Fed staff inflation forecasts that account for the impact of both implemented and planned tariffs are likely to point to core inflation above 2% in 2020–our own forecast is 2.2%–but most participants are likely to be conservative about showing an overshoot”, the bank says.
On the dots, Goldman has this to offer:
We expect the September dot plot to show a substantial minority, roughly six participants likely including the Chair and Vice-Chair, in favor of a third 25bp cut later this year. We think such an outcome would send a strong signal of a third cut this year and would not be taken as particularly hawkish by investors, even though this would of course mean that the median dot would not show further easing. After all, in June a large minority showing cuts this year was sufficient to send a clear dovish signal. Beyond 2019, we expect the dots to show one hike in each of 2020 and 2021, though our projections come down to a single participant.
For their part, BofA expects a dovish outcome and also a solid performance from Powell in the press conference. Both of those outcomes seem optimistic.
“All eyes should be on the second paragraph in the statement”, the bank says, in their own preview. BofA says the Fed will keep the “act as appropriate” language, but suggests a possible enhancement conveying a bias to cut (e.g., “As the Committee contemplates additional interest rate reductions….”). Frankly, something as explicit as that seems far-fetched, especially considering George and Rosengren’s likely dissents.
BofA goes on to say that the Fed “will also tweak the language in the first paragraph to reflect a less upbeat [take] on the labor market [and] a more cautious tone about the consumer given the drop in sentiment”. That’s the counterpoint to our assessment above and here’s a representative chart:
As far as the press conference goes, BofA is hoping against hope that Powell doesn’t fumble the handoff as he’s wont to do. To wit, from the bank:
In the July press conference, Chair Powell struggled to explain the rationale for the cut given the strength in the economy. He tried to square the circle noting that part of the reason the economy has fared well is because of the Fed’s guidance of easier monetary policy. In other words, the Fed did not see the strong data in the summer as a reason not to cut but as confirmation that signaling a cut was the correct policy. The story has shifted since then given the softening in economic data and the escalation of the trade war.
On the dots, BofA predicts the Fed will “send a clear signal that they are open to easing policy more with the median moving to 1.625% implying 75bp of easing this year”. Looking out, the bank expects the new plot to show the Fed will “hold rates at these levels through 2020 before signaling a gradual tightening in 2021 and 2022”.
“Since a 25bp cut is already almost fully priced by the market, the SEP [and] especially the dot plot, and Chair Powell’s press conference will likely drive price action”, Barclays noted on Sunday. The bank is still looking for 75bp in cumulative cuts by the end of the year. Here’s a short excerpt from them:
We expect the Fed to keep its rhetoric unchanged and restate that it is ready to act as appropriate to sustain the expansion. In our view, the median dot for 2019 and 2020 will be marked to market to account for the cuts delivered so far (to 1.875%), but some Committee members will likely signal further easing to come, which should validate market expectations.
For what it’s worth, below is an annotated chart from Goldman which shows what Fed funds futures are pricing in total. As the bank notes, markets are now pricing “46bp of further cuts this year plus an additional 39bp beyond 2019 for a total of 85bp, down sharply from the peak of 134bp on September 4”.
(Goldman)
That paring of rate cut bets has of course coincided with a rapid backup in long-end yields, which culminated last week in a massive bond selloff.
For his part, renowned rates strategist Donald J. Trump (of 1600 Penn. Asset Management fame) has an out-of-consensus view. He’s looking for a roughly 300bps cut and an announcement of $100 billion/month in asset purchases.
….The USA should always be paying the the lowest rate. No Inflation! It is only the naïveté of Jay Powell and the Federal Reserve that doesn’t allow us to do what other countries are already doing. A once in a lifetime opportunity that we are missing because of “Boneheads.”
— Donald J. Trump (@realDonaldTrump) September 11, 2019
As noted, he’ll probably be disappointed.
