• The Fed delivers 25bps rate cut to a range of 1.75% to 2.00%

• The Fed’s September meeting follows its first rate cut since the financial crisis, a 25bps reduction in July

• The FOMC is split on what action the Fed should take moving forward

• The dot plot median points to steady rates through the end of next year

• Further easing will come

Fed Reserves cut federal funds rate by 25bps to 1.75%-2.00% as widely expected, its second cut since late July, and suggested it was prepared to move aggressively if the United States economy showed additional signs of weakening. The decision certainly was not unanimous with both Esther George and Eric Rosengren, like in July, opposing the 25bps rate cut. On the other side James Bullard argued for a more aggressive response of a 50bps cut to 1.50%-1.75%.

The outcome was about 95% priced in to the market, so markets were more interested in the central bank’s monetary policy statement, summary of economic projections and Chairman Powell’s press conference.

1) Monetary Policy Statement

As is often the case, there were only token adjustments to the Fed’s monetary policy statement from the one published in July with an upgraded assessment on household demand (“rising at a strong pace”) offset by a more negative opinion on trade and investment (both have “weakened”). One remarkable aspect is the fact there was no acknowledgment of the recent sharp pick-up in core CPI or average hourly earnings – both of which are running at their fastest 3-month annualised rates since before the financial crisis. Instead, the statement persists with the line “market based measures of inflation compensation remain low” while in the press conference Fed Chair Jerome Powell suggested inflation pressures "clearly" remain muted. Beyond those minor adjustments, the only other noteworthy development was that three members of the FOMC dissented from the group’s decision.

2) Summary of Economic Projections

As with the monetary policy statement, the biggest surprise in the Fed’s economic projections may be the lack of changes. Despite all the geopolitical and economic developments over the last three months, the central bank left its projections essentially unchanged from June. While there were minor tweaks at the margin (GDP and unemployment forecasts were raised by one tick for 2019 and the GDP forecast for 2021 also ticked up), these were generally marking the current forecasts “to market,” rather than making a substantive change to the economic outlook.

GDP projections (median):

• 2019, up from 2.1% to 2.2%.

• 2020, unchanged at 2.0%.

• 2021, up from 1.8 % to 1.9%.

Unemployment rate projections (median):

• 2019, up from 3.6% to 3.7%.

• 2020, unchanged at 3.7%.

• 2021, unchanged at 3.8%.

Core PCE projections (median):

• 2019: unchanged at 1.8%.

• 2020: unchanged at 1.9%.

• 2020: unchanged at 2.0%.

Federal funds rate (median):

• 2019, down from 2.4% to 1.9%.

• 2020, down from 2.1% to 1.9%.

• 2021, down from 2.1% to 2.4%.

• 2020, 2.4% (new).

The median projections of federal funds rate are at 1.9% in 2019 and 2020, then rises to 2.1% in 2021. Just based on this median figure, with federal funds rate currently at 1.75%-2.00%, Fed is already done with its “mid-cycle” adjustments. However, based on the dot plot, it’s not totally certain and here is still risk of further rate cut this year.

This may be a little disappointing for those expecting a more dovish Fed outlook, but it would not matter much for markets, who continue to price another Fed funds rate cut from current level. After all, the June median Fed forecast was for no rate changes in 2019 yet the Fed have delivered two 25bps cuts within three months of publishing that prediction.

3) Chairman Powell’s Press Conference

The Fed chair, Jerome Powell, said at a news conference after the meeting that the US economy remained strong and unemployment low, but that “there are risks to this positive outlook”. Fed Chair Powell said the interest rates were lowered to keep economy strong and provide insurance against risks although the baseline outlook remains favorable. He stressed that the Fed will be highly data dependent, particularly monitoring global growth and trade developments. While the Fed will stop cutting interest rates “when we think we’ve done enough”, Powell also added that the Fed is prepared to be “aggressive” if it turns out to be appropriate. If the economy weakens, he said, a “more extensive sequence” of rate cuts could be appropriate.

Further easing will come

The rate cut was widely expected as the Fed continues its “mid-cycle” policy adjustment i.e. more than one cut, but not an extended easing cycle. The key question is how much further that adjustment, framed as insurance against risks from trade tensions and slowing global growth, will go. The clearest indication should come from the dot plot - it shows a median of no further cuts (or hikes) through the end of next year. But that masks significant divergence among committee members with seven expecting one more cut this year, five looking for no change, and five thinking a rate hike would be appropriate by year end. Lack of consensus might explain why the policy statement was little changed, simply reiterating that the Fed will “act as appropriate to sustain the expansion”.

Our forecast assumes the Fed will lower rates once more this year. A total of 75bps of cuts would be consistent with mid-cycle easing in 1995 and 1998. Whether the Fed makes that additional move will depend on how the balance of risks around the economic outlook evolves into year end. Geopolitical risk has gone both ways recently, with the US and China restarting trade talks but tensions in the Middle East rising and Brexit no closer to being resolved. Latest Chinese data only underlines our fears about global growth story while the latest round of ECB policy easing is unlikely to be the catalyst for a phoenix from the flames like recovery in Eurozone activity.

Trade tensions will also remain an issue. We doubt October’s US-China trade talks will yield much. At best we may see discussions continue over coming months which means this threat to growth persists, even if it does not necessarily intensify.

Domestically, more reports like the IPI numbers (IPI rose 0.6% mom in August with manufacturing +0.5% mom) would help alleviate concerns about the health of the US industrial sector, with the key worry being that weakness there spills over into the broader economy. The consumer sector is performing well, but with payrolls growth showing signs of slowing and net trade and investment spending becoming drags on growth we worry about how long this can be sustained. To us, this justifies further “insurance” policy cuts. More clarity on these issues would help the divided Fed reach a consensus.

Source: BIMB Securities Research - 19 Sept 2019