Fed: The September Meeting

Published on September 16, 2019
SGH Insight
A 25 basis point rate cut is all but certain to be announced this coming Wednesday afternoon when the Federal Open Market Committee concludes its two-day September meeting. Now the overhang of the shock attack and disruption to Saudi Arabia’s oil output is certain to add to the growing sense of uncertainties and risk probabilities hanging over the FOMC’s deliberations. Whether the 2019 median comes in at no more rate cuts after this Wednesday, or perhaps just showing one more cut feels almost beside the point; in any case there is likely to be enough rate dots showing still one more easing beyond the expected rate cut on Wednesday is on the table. Equally, the rate dot projections further out will carry even less real information, though it is probably safe to assume the medians will not be as gloomy as the market pricing. The rate dots for 2022, for instance, may prove to show a clearer bifurcation of the Committee projections, with nearly half showing a return to rate hikes, perhaps even beginning in 2021, while an equal near half showing an extended period of a flatlined policy rate.
Market Validation
(FT 9/18/19)

The Federal Reserve cut US interest rates by 25 basis points, to a range of 1.75 to 2 per cent and signalled that it could stop there despite uncertainty over trade and fierce pressure from the White House for more accommodation.

The one-notch cut was in line with the expectations of investors and economists, but its projections show a more hawkish line than markets had anticipated. The median projection among its rate-setting committee showing a flat path through the end of 2020.

Futures data compiled by Bloomberg before the meeting showed that investors had expected two more cuts by the end of 2020.

Treasuries lost earlier gains following the Fed’s widely expected cut, with the yield on the 10-year note climbing to 1.775 per cent. The yield on the policy-sensitive two year note jumped from 1.66 per cent ahead of the announcement to 1.72 per cent.

US stocks slipped, with the S&P 500 down 0.7 per cent and the Dow Jones Industrial Average down 0.6 per cent. Meanwhile the dollar rose 0.31 per cent.

A 25 basis point rate cut is all but certain to be announced this coming Wednesday afternoon when the Federal Open Market Committee concludes its two-day September meeting. Now the overhang of the shock attack and disruption to Saudi Arabia’s oil output is certain to add to the growing sense of uncertainties and risk probabilities hanging over the FOMC’s deliberations.

A few points on our sense of the likely takeaways from Wednesday:

** Still more downside risks, in higher oil prices that even if relatively temporary will undercut near term growth abroad, a likely sustained higher risk premium in oil prices, not to mention the prospect of outright military conflict in the Gulf, will we think both solidify the Committee consensus for the second 25bp rate cut and color Chairman Powell’s post-presser policy messaging with a clearer sense of the FOMC’s willingness to ease further as needed.

** We still believe there are almost no odds for a 50bp rate cut, and equally for no rate cut at all. Despite the uneasy reluctance of nearly half the Committee going into the pre-meeting black-out, we think there is pretty solid majority Committee consensus, among the voters anyway, for the second of the two insurance rate cuts started in July.

** And on the margin, the added uncertainties from the Persian Gulf may soften the resistance to a rate cut among the more reluctant Committee members, perhaps even to the point of removing one or both of the hawkish dissents. Even if not, we still think that is where the center of the Committee debate is going, in tipping the balance of the Committee’s leanings towards the potential need for more easing despite the still relatively decent real economy data.

** The tensions in the Mideast, on top of the uncertainties over trade policy and tariff threats that are already widening the confidence bands around the base case forecast, are also only adding further to our caution about any meaningful takeaway from the rate dot projections.

** The September projections, with only two meetings remaining, always tend to feel even more like forward guidance even if Fed officials insist they are not. There is also a sense, even if Fed officials insist it is not true, that the rate dot plots are gamed a bit more in the pre-meeting discussions to fit them a bit closer to the likely consensus coming into view.

** So with that in mind, whether the 2019 median comes in at no more rate cuts after this Wednesday, or perhaps just showing one more cut feels almost beside the point; in any case there is likely to be enough rate dots showing still one more easing beyond the expected rate cut on Wednesday is on the table.

** Equally, the rate dot projections further out will carry even less real information, though it is probably safe to assume the medians will not be as gloomy as the market pricing. The rate dots for 2022, for instance, may prove to show a clearer bifurcation of the Committee projections, with nearly half showing a return to rate hikes, perhaps even beginning in 2021, while an equal near half showing an extended period of a flatlined policy rate.

** To be sure, the risks to the base case are all to the downside and the probabilities-based assessments are invariably outweighing the relative relief in the still decent domestic economic data. That, we think, means one more 25 basis point rate cut will be kept on the table, if needed.

** As we wrote previously (SGH 9/4/19, “Fed: The NFP, Powell, and the September FOMC”), an FOMC majority believe bringing the policy rate back below 2% again and safely under best estimates of the short run r* with a second rate cut this week is a low-cost insurance that will help soften the impact of the slowing growth to date.

** Importantly, these more precautionary 25bp rate cuts should also taper down some of the tail risk to even greater damage if the economy should truly turn south and need a much more rapidly delivered accumulative accommodation.

** This is the so-called “Reifschneider-Williams” playbook of “swift and aggressive” rate cuts to maximize the punch of the limited room for easing in the uncomfortable proximity to the Effective Lower Bound. It has to be said that no one in the FOMC sees the current outlook warranting such an aggressive response. At least not yet.

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