As anticipated, the FOMC reduced its target range for the federal funds rate to 2.00%-2.25%. The FOMC also brought forward the end date of its balance sheet reduction programme by two months, in August. However, Fed chairman Powell framed the 25bps rate cut as a mid-cycle adjustment rather than the start of an aggressive easing cycle, which led to disappointment in the financial market. We opine the FOMC remains on a fluid course and will continue to be data dependent. Should US-China trade tension continue and inflation remain muted, we opine the Fed may lower the interest rate towards the end of the year.

DATA HIGHLIGHTS

As anticipated, the FOMC reduced the target range for the federal funds rate by 25bps to 2.00-2.25%, citing implications of global development for the economic outlook, trade policy uncertainty as well as muted inflation pressures. In line with keeping with the monetary policy slightly more accommodative, the FOMC also decided to conclude the reduction of its balance sheet programme on 1st August, rather than at the end of September as previously indicated.

Overall, the FOMC was neutral on the economy. While it maintained its assessment on job market and consumption, it was less sanguine on investment and inflation prospects. The Committee said job gains have been strong, and the unemployment rate remained low. Although household spending appears to have picked up from earlier in the year, business fixed investment continues to be soft. On inflation, the Committee noted that overall inflation and inflation for items other than food and energy are running below 2%. Market based measures of inflation expectations have remained low while survey-based measures are little changed. While the Committee continues to view sustained expansion of economic activity, strong labour market and inflation near the 2% objective as the most likely outcomes, uncertainties about this outlook remained.

2019 GDP was maintained at 2.1% and anticipated to ease to 2.0% in 2020. The longer-run GDP remained at +1.9%. Unemployment forecast in 2019 was retained at 3.6% and expected to increase to 3.7% in 2020. Forecast for 2019 and 2020 PCE deflator was at 1.5% YoY and 1.9% YoY respectively. Core PCE deflator forecast was also maintained at 1.8% YoY and 1.9% YoY for 2019 and 2020 respectively. For 2019, FOMC members’ projection of median fed fund rate was at 2.4%. However, FOMC members’ median fed fund projection was lower at 2.1% in 2020 before moving up to 2.4% in 2021. The estimated longer-run rate was also reduced to 2.5% (previous: 2.8%).

HLIB’s VIEW

The 25bps cut was the first interest rate reduction since December 2008. This represents a turnaround from the monetary policy tightening stance adopted since 2015. However, the decision was not unanimous as there were two dissenters who preferred to keep the interest rate steady (Esther L. George and Eric S. Rosengren). More importantly, FOMC chairman Powell also explained this rate cut as a mid-cycle adjustment to policy, not a response to recent US economic reports. Nevertheless, we opine the FOMC remains on a fluid course and will continue to be data dependent. Should US-China trade tension continue and inflation remain muted, it may lead the FOMC to cut another 25bps towards the end of the year. Back in 1995, when the unemployment rate was declining and inflation was moderating, FOMC reduced interest rate by total of 75bps for insurance against weakening economy. Closer to home, while we are currently maintaining our expectation for BNM to maintain OPR at 3%, a worsening global environment may also tip BNM to reduce the OPR by 25bps.

Source: Hong Leong Investment Bank Research - 1 Aug 2019