Scarred memories of the savage south-bound turn in markets last December were clearly at play in the scripted messaging by Federal Reserve Chairman Jerome Powell and other Fed officials speaking the long planned two-day research “framework” conference in Chicago.
*** We believe Chairman Powell added the carefully worded “closely monitoring” insert into his opening remarks to the conference yesterday to avoid the December mistake in seeming “tone deaf” to market anxieties and pricing, this time in the bond markets, that led to the dramatic downturn. But an “as always” phrase was also added to make the high profile insert right at the top of his speech as politically neutral as possible, and to soften the appearance of excessive policy volatility or a firm commitment to a rate cut in affirming the Fed would “act as appropriate.” ***
*** Nevertheless, most telling was what both Powell and Vice Chairman Richard Clarida did not say: no mention of the earlier “transient” inflation, nor “patience” (though Dallas Fed President Robert Kaplan did later last night), nor any suggestion policy could “go in either direction.” Though constrained at the May Federal Open Market Committee meeting, we think the still vocal and influential Committee minority view for a more aggressive accommodation (SGH 4/22/19, “Fed: A Pre-emptive Rate Cut ‘Recalibration’”) is already going some way in shaping the likely June meeting outcome. ***
*** Indeed, taking the rapid-fire policy messaging of the last few days into account, we think the Fed is likely to adopt an easing bias in the June 18-19 FOMC meeting statement. On balance, unless Friday’s Nonfarm Payroll print or other data by mid-June display a shock downside drop, we do not have any sense the FOMC is yet willing to deliver a rate cut in June, but rather to position for a potential rate cut at the July FOMC meeting. Whether by 25 bp or 50 bp, if at all, will depend on the early evidence of the trade effects or signs of financial market stress. ***
Pulled into the Trade Policy Orbit
While there is that Committee minority who would make the case for a rate cut reset or recalibration sooner rather than later in waiting for the data to pave the policy path, we do not think there is anything like a Committee consensus yet for rate cuts to the extent of the current aggressive market pricing.
We think Chairman Powell is instead wanting for now a more neutral stance with the easing bias to maintain the policy option, however low its probability may be looking, to hold rates steady for as long as possible until the trade effects become clearer and in theory, the political optics of a rate cut are less potentially damaging.
In other words, in the current consensus, both growth and inflation will still need to substantially falter before a more aggressive reaction function kicks in. And that will almost entirely depend on the twists and turns in the Trump Administration’s trade policies; in that sense, the Fed, for better or worse, is being pulled into the policy calculations of the Trump White House.
We think a sudden reversal in the Trump Administration’s increasingly hardline stance in its trade negotiations with both China and now Mexico is increasingly unlikely (see, for instance, today’s earlier report SGH 6/5/19, “Mexico: First Round of 5% Tariffs Coming”).
Under such a trade policy scenario that will only become clearer after the FOMC’s mid-June meeting, perhaps at the June 28-29 G20 meeting, we think Chairman Powell is therefore trying to position the Fed for a maximum flexibility to react quickly and decisively, depending on the extent to which the uncertainties of the trade policies are starting to ripple across the economy in derailing business capital expenditures, for instance, or undercutting consumer confidence.
A Grain of Salt on the June Rate Dots
One other point to make in passing is the significance, or lack of it, in the June meeting Summary of Economic Projections and the rate dot plots. The dots in particular have proven to be more miss than hit in aligning with the intended policy messaging takeaways these last few years, but the potential for a policy messaging mess is especially high in June.
As we noted in a report last month (SGH 5/22/19, “Fed: Steering Clear”), the confidence bands around each of the Committee member forecasts are going to be unusually wide due to the unprecedented degree of uncertainty on trade or oil sanctions policies and the economic outlook. Those wide confidence bands will also play into the rate dot plots over the three-year forecasting horizon because it is impossible to convey alternative reaction functions in what are only meant to base case rate projections.
Powell made a point in his conference introductory remarks to note the poor guidance the dots are likely to provide “in times characterized by large, frequent, unexpected changes in the underlying structure of the economy.” That would be an apt description of current politics, policies, and market moves, and traders should take note by taking the rate dot plot with a huge grain of salt.