We still see the federal funds rate being cut to 0.875%, though the timing is uncertain.
At its October meeting, the FOMC delivered a third consecutive cut. Looking ahead, with insurance now taken and the Committee’s central view constructive, policy will become reactive.
The Committee’s broad view on the economy was unchanged in October. The “labor market remains strong” and “economic activity has been rising at a moderate rate”, although this growth is unbalanced. While “household spending has been rising at a strong pace, business fixed investment and exports remain weak”. Also of concern for the Committee, “overall inflation and inflation for items other than food and energy are running below 2 percent”, with lasting consequences for inflation expectations.
Having now taken out 75bps of ‘insurance’ however, the Committee as a whole has less concern over the above points of weakness (business investment, exports and inflation) and hence sees little need to remain pre-emptive with policy.
Highlighting this, in the September statement, the FOMC outlined that as “the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion”. Come October, this statement has been replaced by the more passive, the “Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate”.
Chair Powell subsequently confirmed in the press conference that he personally sees monetary policy as being in a good place and that, to see a further easing of policy, “a material reassessment of our outlook” would be required. Specifically, moderate US growth on the back of robust consumption, the labour market’s strength and/or inflation tending to 2%yr would need to be seen as ‘at risk’.
On global uncertainties, Chair Powell also noted in the press conference that he viewed the threat from US/China trade tensions and Brexit as having subsided somewhat since the September meeting – though it also should be recognised that he saw “plenty of risk left” on both fronts. At least for the time being, for the Committee, this is another reason for policy to be reactive rather than pre-emptive.
We remain of the view that the FOMC will need to ease further if it is to achieve its aims of sustaining growth near trend and inflation at target. However, how much evidence against their current view they will require to act is, as yet, unknown.
During the next two weeks, updates will be received for employment, wages, the ISMs and retail sales. If these reports show a further marked deterioration in employment and wage outcomes, or vis a vis the ISMs the threat of one in the near future, then the FOMC could justify acting again in December as per our current forecast (note the November employment report and ISMs will also be received before the FOMC meets again in December). Further, should October retail sales materially disappoint, then the FOMC may fear the prime pillar of the US growth story (consumer demand) is at risk of crumbling and in need of additional support.
But, to the extent that Chair Powell sees the current policy stance as “very likely” accommodative and assuming global uncertainties remain benign in the inter-meeting period, the FOMC could instead decide they are justified to wait to see what 2020 brings before reassessing their policy stance.
If December is missed, then the case for the next cut is still likely to be made by March 2020, as businesses remain reluctant to invest amid persistent global uncertainties (the effect likely accentuated by domestic political risk ahead of November’s Presidential election), and as these forces also have a greater effect on employment and wages.
In closing, note that to see a run of rate cuts to 0.875% in mid-2020 as we are forecasting does not require labour shedding. Instead, with consumption the almost sole support for GDP growth, arguably a reduction in hiring to (or a little below) the pace of population growth would create concern over whether GDP growth can be sustained near trend, inflation at target, and the unemployment rate at its 50-year low. These are the aims of the FOMC. They have both the scope and the will to achieve them.
