Against the backdrop of the dueling remarks in recent days from several members of the Federal Open Market Committee, and conveniently just a few hours after a crucial Non-Farm Payrolls print this Friday, Federal Reserve Chairman Jerome Powell will take the stage in Zurich for tightly scripted Q&A to reassert control over the Fed’s policy narrative on the very eve of the blackout before the FOMC’s September 17-18 meeting.
*** Working from back to front, we still think the most likely outcome to the September FOMC meeting will be a 25 basis points cut in the target range for federal funds to 1.75%-2%. While a 50bp rate cut will be on the table, we still do not sense much momentum that would shift the likely consensus towards the larger rate cut, or for that matter, in the other direction to no move at all. A 50bp rate move could look panicky and hard to explain, at least without significantly weaker data, and it would use up valuable accommodation ammunition when so near the dreaded Zero Lower Bound. ***
*** We also expect a 25bp rate cut to be complemented with a clear bias for further easing if conditions deteriorate or risk assessments continue to rise, tipping the risk management scales to further “insurance” accommodation. We don’t expect the September Summary of Economic Projections to change all that much from June, in large part because we also expect the rate dot plots to further flatten out in 2020 and 2021, and on balance, for a 2019 rate median to leave a door open for more accommodation beyond the September cut before year-end. ***
St. Louis Fed President James Bullard added his voice to the call by Minneapolis President Neel Kashkari in making the case for a 50bp rate cut in September, primarily to get in front of the market pricing and a deeper deterioration in the economic outlook with the trade wars looking to become more sustained over a longer time frame – and indeed, our sense is that perhaps a Committee majority are increasingly becoming resigned to the trade wars becoming a protracted conflict that will erode trade flows.
A deeper rate cut, in that sense, is a modestly larger insurance easing, and with inertial inflation posing no upside threat, if the larger insurance proves not to be needed, it could in theory be taken back with rate increases next year or in 2021.
Boston Fed President Eric Rosengren neatly articulated the juxtaposed view more or less closely shared by Kansas City’s Esther George, that the economy is doing just fine, thank you. That said, however, in acknowledging elevated downside risks around the base case outlook, both of the more hawkish-leaning dissenters have also left the door open to easing aggressively “should those risks become a reality.”
We suspect their arguments — shared by enough of their Committee colleagues to equal a near majority of non-voters — will limit the scale of a rate cut in September to 25bp.
But it is also moving the ultimate rate debate to the late October meeting, when there may perhaps be at least some further clarity on the Trump Administration’s trade policies, and the state of play in the negotiations with China in particular, or for that matter, a sense of where the British debate over a hard Brexit is going, a development that is being closely watched in particular by Fed officials for its downside risks.
So again, keeping in mind that if the data is too clear, it invariably means the Fed is behind the proverbial curve, we do think it will take a clear deterioration in data to move the wider Committee to unify around a larger rate cut in September or further, more aggressive accommodation later in the year.
The NFP and Powell on Friday
One data point does not a trend make, but more than would be the case in “normal” times, this Friday’s NFP will carry considerable sway in the September policy outcome, with the caveat that the August NFP has tended to be almost always revised.
With a 25bp rate cut as the base case going into the meeting, it will nevertheless take an unusually strong NFP to pull the consensus back to no rate cut, and an unexpectedly weak NFP to push the Committee to the larger 50bp. A watchful eye will be put on the average weekly hours breakdown in particular for an early hint that businesses are as cautious in hirings as they have become in capital spending.
The NFP will also influence what Powell has to say in his remarks a few hours later. It is interesting in itself that the Chairman opted against a set speech after multiple staff drafts with the usual footnoted academic research for what instead will be a moderated “Q&A” on stage. If he takes to notes in his lap, it will be a neat echo of his carefully scripted answers at the American Economic Association remarks in Atlanta last January when he launched the “policy pivot.”
We doubt, however, his intended takeaways will be anything as dramatic: yes, he may bat down, even roughly, the unfortunate op-ed by former New York Fed President William Dudley about intervening in the 2020 US elections. And as explosive as it would be if he did, we doubt he will take a swipe at President Trump or the trade wars at all, beyond affirming the Fed will treat any trade shocks like any other shock, be it an oil price spike, or a fiscal cliff, and respond accordingly.
Instead we suspect he is likely to expand on some of his points from Jackson Hole — all but buried by the trade war escalations later the same day — that there are limits to what monetary policy can do, how the trade uncertainties are widening the probability bands around the Fed’s base case outlook and rate path projections for an economy that is otherwise still showing impressive resilience.
Above all, without reference to the scale of any looming accommodation, we expect Chairman Powell will repeat the boilerplate statement guidance that the Fed will “act as appropriate” to sustain the current record expansion, and that he will not be pushing back against the current market pricing for that 25 bp rate cut later this month, or even the deeper rate cuts being priced by the market through the end of the year.
After all, that dovish pricing is maintaining easier financial conditions to cushion the economy until data begin to tell a different story that might warrant a scaling up of monetary accommodation.
And finally, while we suspect it is a tad too early, it would be quite interesting if Chairman Powell used his moderated Friday remarks to give the markets a taste of the progress to date in the Fed’s internal review of its policy framework.
One question that stands out in light of the scenarios of “swift aggressive rate cuts if the economy turns south in such a proximity to the Zero Lower Bound” is whether the FOMC is weighing whether a more assertive forward policy guidance or even a return round of large-scale asset purchases before reaching the ZLB rather than waiting till rate policy is exhausted? There was a curious hint at such a discussion in the July meeting minutes, and so we are left to wonder.