Fed has removed its ‘will act as appropriate’ easing bias
In line with expectations, the Fed delivered another 25bp cut at today’s meeting, taking the target range down to 1.75-2.00%. Again, Esther George and Eric Rosengren voted against the cut, while James Bullard, who voted for a 50bp cut in December, voted for the 25bp cut in line with the rest of the FOMC this time.
A bigger surprise, at least to us, was the change in the forward guidance in the statement, as the Fed has removed its easing bias without pre-commitment. The statement now says that the committee ‘assesses the appropriate path of the target range’ (versus ‘act as appropriate to sustain the expansion’ previously). Fed chair Jerome Powell made it clear during the press conference that the Fed now believes the current stance of monetary policy is ‘appropriate’. Despite the improvement in risk sentiment, we thought the committee would have become more worried about the US data, which in our view have worsened, with PMIs indicating growth around 1.0-1.5% q/q, falling business investments, slower jobs growth and lower inflation expectations.
It seems as though the Fed now wants to stay on hold, at least for a while, to see how things play out and the bar for another cut in December seems to us high. This also means our call for three additional cuts at the next three meetings (including December) is stretched at this point. However, there are six weeks to the next meetings, in which we are due to get, for example, two more jobs reports, so it is still too early to rule out completely further cuts. We thought that the current economic situation would be enough for the Fed to deliver more cuts but it seems to us that data need to deteriorate further.
We plan to review our Fed call after, for example, the jobs report on Friday. However, we stress that the tail risk to the US macro outlook increases without further easing, which, if it materialises, would force the Fed to cut faster and more.
Market is still looking for more cut
The initial market reaction to the statement at the beginning of the press conference was in a hawkish direction, as the market sent short-term USD rates higher and EUR/USD lower on the wait-and-see hints from Powell. In the end though, the market stayed with its pre-meeting belief that the Fed could continue the rate cut cycle of the coming months and actually added a bit to that view. EUR/USD ended some 30 pips higher, close to 1.1150, supported by the decline in short-term USD rates. We have long argued the case for a higher EUR/USD once the Fed got ahead of the curve in the easing cycle. We stick to this view but the signals from the Fed today suggest this is still a story for Q1 20. Liquidity operations were once again a hot topic at the press conference but Powell did not offer any new details on the Fed’s thinking. In turn, funding markets remained calm, e.g. Dec 3M USD FRA-OIS stayed about unchanged close to 40bp.
We saw a bearish curve flattening 2s10s today and, given the change to the Fed’s rhetoric, we believe this flattening could continue. We expect to see support for German bunds tomorrow given the move lower in long-dated treasuries and US breakevens
