The apparent downshift in the labor market indicated in this morning’s Non-farm Payrolls print is highly unlikely to shift the low probabilities for a rate cut at the June 18-19 meeting of the Federal Open Market Committee, but it should solidify the odds for an implicit easing bias in the June statement.
*** As we wrote earlier this week (see SGH 6/5/19, “Fed: An Easing Bias”), we think it very likely the FOMC will adopt an easing bias in tweaks to the statement that would better position the Fed on the odds for July meeting rate cut. The signaling shift will probably come in dropping the “patience” language, in place since the January policy pivot, replaced by the “closely monitoring” phrasing Fed Chairman Jerome Powell introduced on Tuesday. ***
*** Barring a sudden reversal in the Trump Administration’s hardline trade posture — always a possibility the Fed will be especially sensitive to — we suspect Chairman Powell will still be careful to shy just short of offering much more than the option for a July rate move. The Committee consensus is still only cautiously edging towards putting a rate cut on the table, and still premising the move on further evidence of a more rapid slowing in growth or elevated downside risks. ***
*** While the end of July FOMC meeting is a lifetime away amid volatile market and trade policy turns, an interesting prospect is whether a July rate cut would be by a cautious 25 basis points, perhaps with another 25bp in September, or if the FOMC would opt to get in front of slowing growth with a more assertive 50 bp cut. On balance, our sense of the current reaction function suggests an aggressive first move against elevated downside risk will be on the table (SGH 3/27/19, “Fed: An Asymmetric Reaction Function”). ***
September Still Looms Large
Before we step too deeply into the tantalizing probabilities for a more definitive 50 bp move, our sense of the current shape of the FOMC consensus is that it will inevitably take a very pro-active effort by a cautious Chairman Powell to push the Committee off its inclination to wait for the data over the summer to tell a clearer story on the economy without the Fed stepping into the trade policy uncertainties.
And as we noted earlier (SGH 5/22/19, “Fed: Steering Clear”), the wide variance around possible trade policies are likely to generate unusually wide confidence bands around the forecasts being prepared for the June meeting.
While we would not preclude more rate dots flatlining across the forecasting horizon or for the median NAIRU estimate being marked down — both of which would be supportive of a more dovish rate outlook — overall we think the FOMC will be taking the June Summary of Economic Projections with a bigger than normal grain of salt that will add to their ingrained sense of caution.
We also suspect today’s NFP will leave its mark on the June meeting discussions in confirming what has been expected to be a slowing labor market, which to be fair, had been unusually strong so far this year.
But we doubt it will be taken as suggesting an unusually large signal for a downshifting growth this summer, at least not yet, and the FOMC will want to see confirming evidence of the down trend in the June numbers and across the data the weeks before the end of month July meeting.
Caution against a “Premature” Rate Cut
And in June, and perhaps July as well, the FOMC will also be on guard against a rate cut that could look “premature” if the dampening effects of the trade wars on growth are lifted in a sudden reversal of the Trump Administration’s hardline trade negotiating stance.
That the Fed could be “enabling” aggressive US trade policies is not a factor; at the end of the day, even if we do think the reaction function would premise an aggressive response to clear downside risk, Fed policy is almost by definition reactive, responding to the economic outlook and its risk parameters, however it got there.
Finally, as one last point, Chairman Powell is certainly keen to keep the economy on a sustained growth path — gone is the soft landing ambitions now replaced with a high pressure economy bet — and will push the Committee to respond with lower rates if either growth is clearly faltering or if downside risks look too elevated, even if growth is not slowing beyond what is already built into the forecasts.
And that, at least for now, is another way of saying neither a more pre-emptive insurance rate cut to get ahead of slowing growth nor “recalibrating” rates down to a lower sense of neutral specifically to blunt the persistence in low inflation are yet built into a Committee consensus.