The Fed will cut rates for the third time in three meetings this week. If they don’t, they’ll blindside markets and incur the wrath of an increasingly irritable Donald Trump, who last week declared that policymakers would be “derelict in [their] duties” if they sit on their hands.
“We believe the mixed growth data since the last meeting more closely resembles the Committee’s baseline forecast than the downside scenarios under discussion”, Goldman writes, in their Fed preview (called “three and out?”). The bank expects “only minor changes” to the statement with regard to the growth outlook.
Here’s a snapshot of how the data has evolved:
The September meeting betrayed a divided committee as Esther George and Eric Rosengren reiterated their dissents from July, while Jim Bullard argued for a larger, 50bp cut. Minutes from the meeting detailed the rift.
“Comments from Fed officials continue to indicate a diverse set of opinions about the appropriate policy stance, with many implying scope for additional cuts beyond October’s, but others professing skepticism about the easing already delivered”, Goldman went on to say last Thursday. The bank expects dissents from George and Rosengren again.
If you ask Goldman (and this prediction was touted by CNBC), the Fed will likely drop the “act as appropriate” language from the statement to indicate another cut in December is not a foregone conclusion. Clearly, that would send a hawkish message to markets, and may be tempered with language that reminds everyone of how much the committee has already done despite little in the way of an economic justification.
“Because even the leadership does not appear to view a fourth cut in December as the default outcome, we expect the statement to drop the pledge ‘will act as appropriate’, a phrase that the market interprets as signaling a cut at the next meeting”, Goldman says, adding that it may be replaced with a nod to the stimulative effects of the cuts already delivered and “with the following less committal guidance: ‘will act as needed to promote its objectives'”.
For their part, BofA expects the language to remain consistent, at least in terms of forward guidance. The Fed will note that “‘[a]s the Committee contemplates the future path…for the federal funds rate, it will continue to monitor the implications of incoming information…’, suggest[ing] that the Fed remains open to the possibility of further rate cuts”, the bank says in their preview of the October meeting. “If the Fed tweaks the statement to note that the Fed believes that the current rate of policy is appropriate and does not indicate that they are ‘monitoring’ data, it will be a hawkish surprise, suggesting that the Fed is likely on hold”, the bank goes on to remark, while noting that “We do not think this is the message that Fed leadership would want to send”.
The October FOMC meeting comes more than six weeks after an acute squeeze in short-term funding markets forced the Fed to intervene with overnight and term repo operations. On October 11, the Fed officially announced the commencement of “organic” balance sheet expansion (“QE Lite”, as it’s affectionately known) at an initial pace of $60 billion per month, with the aim of alleviating reserve scarcity.
Although Powell will certainly be asked to deliver an update on that during the press conference (his performance in that regard last month was characteristically lacking), there likely won’t be a mention of it in the statement.
“Look for Powell to reinforce the key words of ‘technical’ and ‘organic’ when describing the reasons behind balance sheet growth”, BofA says, noting that he’ll “be clear that it is different than QE [but] may be pushed on some of the implementation challenges, particularly the question of whether or not there will be enough supply to meet the Fed’s demand for T-Bills”.
It’s highly unlikely that the calming of trade tensions since the September meeting will dissuade the Fed from squeezing in another “insurance” cut. “Strong signaling from Fed leadership indicates that the modest trade war de-escalation has not deterred them from completing a 75bp, 1990s-style ‘mid-cycle adjustment'”, Goldman said.
The so-called “Phase One” trade deal is nebulous in the extreme and although it appears likely that Trump will make a show of signing something with Xi Jinping at APEC in November, markets will remain skeptical. Indeed, some surveys indicate that most market participants believe trade tensions between the US and China are the new normal. In any case, it’s too late to rescue the global economy. The only question is whether the downturn morphs into a recession proper.
Goldman (and others) ultimately expect the December tariff escalation to be delayed and indeed, there was more than a little chatter about that last week.
Still, it’s far from a sure bet, and even if Trump does announce that the scheduled imposition of duties on $160 billion in Chinese goods is off the table, the president has been known to change his mind. That escalation, if it goes forward, would come within days of the December FOMC meeting.
“Recent softer US data would justify the October cut [but] the temporary easing of global risks reduces the need for further insurance, and the Fed could signal more willingness to follow a ‘meeting-by-meeting’ approach”, Barclays mused late last week, adding that “a mildly hawkish cut could bring minor support to the USD”.
And that, right there, underscores one risk. The dollar has been on the back foot lately, and Trump likely won’t be pleased if a “hawkish” cut changes that.
It’s worth noting that retail sales declined for the first time since February in September, and the outlook for the manufacturing sector remains tenuous, although the latest Markit PMIs weren’t a total disaster. ISM and, of course, the jobs report and GDP, are on deck this week.