Fed: October Judgment Call

Published on October 3, 2019

The takeaways from the Non-Farm Payrolls due out Friday will go a long way towards determining whether the sharp, sudden southern turn in the data over the last few days tips the balance within the Federal Open Market Committee to a third rate cut this year at their October 29-30 meeting.

A few quick points before tomorrow morning’s NFP print:

** As we noted in our last report (SGH 9/26/19, “Fed: Disparate Perspectives”), while there is a higher bar to a third rate cut than in July or September, a voting majority of the Committee would be willing to undertake a third rate cut this year if the softening in the manufacturing sector looked to be spreading into the broader economy. We also thought there was likewise an expectation, or at least a preference, to wait until December before weighing a potential rate cut in order to see how the data play out. Our sense is the recent downshift in data has forced that decision point forward to October.

** While the probabilities for the FOMC to embrace a rate cut later this month are not nearly as certain as the jump in market pricing today, we do now believe a rate cut will be on the table in October with a muscular minority of the Committee likely to be soon making the case for a rate cut sooner rather than waiting for more data. If there is any noteworthy weakness across the NFP, in headline jobs, the unemployment rate itself, or discernible downward movement in the average workweek, that case is likely to gather momentum and begin to show up in Fedspeak over the coming weeks.

** As if on cue, Federal Reserve Chairman Jerome Powell is due to speak Tuesday at the National Association of Business Economists conference in Denver, normally an ideal platform for a major policy speech to message and manage markets expectations going forward. Coming only two days after the NFP print, it should offer the Chairman a well-timed opportunity to lay out the Fed’s takeaway from the mix of the ISM and NFP data as well as to frame the Fed’s likely reaction function in how it will be interpreting the remaining data before the October meeting.

** But what makes a third rate cut consideration a bit more complicated than the two previous “insurance” rate cuts of July and September is that even thinking about another rate cut will effectively be putting a 50bp on the table as well. That is because even the more hawkish-leaning Committee members accept the logic of the so-called “Reifschneider-Williams” playbook for aggressive rate cuts in the current proximity to the Effective Lower Bound. While it would be premature to assign high odds on that outcome based on the current data, the point is a 50bp rate cut will be on the table if the FOMC opts for more accommodation.

** It is important to step back from the grim reaction to the recent soft data to remind that the October rate decision will still depend on the story the data are telling on whether it all seems to be confirming a broader slide to stall speed. So if the NFP continues to show relative resilience in the labor market that, along with real wage growth, is the cornerstone to the base case for a continued, just above trend growth, it would keep the base case of a softer pace of growth that remains as limited as assumed just a week ago. It would certainly delay any clarity in the Fed rate policy until at least the next important data marker, namely the October 16 retail sales print.

** So whatever the story told in the data, the Fed’s near policy narrative may still prove tricky to message: if the FOMC opts for no rate move in October and instead leaves the focus on the balance sheet decisions, it is going to need decent data between now and the meeting to support their rate caution and reverse the market’s gloomier pricing; but equally daunting would be to explain another 25 basis point cut as another “insurance” cut, if for any other reason, our sense is that most of the Committee doesn’t really buy into the insurance concept anyway and would rather wait for clearer evidence of persistent weakness before making a rate decision.

** But most challenging of all perhaps, if the FOMC opts to be more pre-emptive with an aggressive 50bp rate cut on top of the “technical” resumption of balance sheet “organic” growth, the Chairman and his Committee colleagues may not only be greeted with taunting tweets, but more importantly they will need to navigate a carefully scripted story line of how the more aggressive rate cut is not the first in a straight line to zero or an enlarged QE that is to come. In other words, cont​rolling the message may prove to be the more difficult and important decision than whether to cut or by how much, if at all.

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