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Comment: Expectations for a rate cut on July 31 nearly universal, but what does that mean?

Expectations for a rate cut at the July 30-31 FOMC meeting are all but universal. Not every Fedwatcher is persuaded that the cut is appropriate right now – I include myself on that list – but are in agreement that one is going to take place.

If it does, it will be the first time since the FOMC adopted a target range on December 16, 2008 and took the fed feds rate to the zero lower bound at 0.0%-0.25% from 1.00%.

Please see the Whetstone Analysis Reference Library for a history of Federal Reserve rate actions.

It is important to remember that policymakers are going to frame their decision within the context of the dual mandate and financial stability. Rhetoric and actions from the White House may have influenced the conditions that will make it necessary to roll back a bit of last year’s tightening. However, by-and-large I would take policymakers at their word that the decision is independent and based on data and developments, not pressure from the Trump Administration.

As an aside, I will note that President Trump has yet to make official his plans to nominate Christopher Waller and Judy Shelton to the Board of Governors. As of this writing, no nomination has been sent to the Senate. It will not be long before the Senate leaves for the state work period that runs from August 5 to September 6. Even if a nomination arrives soon, there probably will be little time to address it given the impending budget fight and/or need to raise the debt limit by the end of September.

Information about the labor market puts unemployment at 50-year lows, hiring at near-record rates, relatively few layoffs, workers on the margins finding employment, and older workers delaying retirement or returning to the workforce. Earnings and benefits are rising, if not as much as might be desired, but still at the best and most consistent pace since the recession. Price stability hasn’t reflected higher wages creating upward pressure and commodities prices are largely absent as a source of higher costs. Things like services and housing dominate upward price movements and may prove to be more of a driver in inflation expectations for businesses and consumers.

As for financial stability, there really isn’t much evidence of undue stress in financial markets. It isn’t the Fed’s responsibility to ensure high stock prices. Rather, it will keep watch for vulnerabilities like the emergence of problems in leveraged corporate debt, or impacts from another showdown over increasing the federal debt limit.

If rates are cut:

  • Kansas City Fed President Esther George is likely to register a dissent. This is in contrast to St. Louis Fed President James Bullard’s dissent at the last meeting in favor of a lower rates. The dichotomy suggests that the consensus among Fed policymakers is a relatively narrow one. At present, almost all the FOMC voters (10 of the 17 FOMC participants) are likely to support giving back the December 19, 2018 rate hike. However, among all FOMC participants, there is a significant minority who think that a cut at this time is not the right policy move given the strength in the labor market, idiosyncratic factors behind inflation readings, firming in inflation expectations, and lack of solid data that the downside risks to the economy are having more than a brief and transitory effect on economic activity.

Please see the Whetstone Analysis comment from July 14, “Which FOMC voters are likely to favor a rate cut? All, almost.

If the cut is 25 basis points:

  • The consensus is for a 25 basis point rate cut in the fed funds rate target range in the current rate of 2.25%-2.50% to 2.00%-2.25%, the same as after the November 8, 2018 meeting. If the fed funds rate is cut, there should be matching reductions in the discount rate from 3.00% to 2.75%, IOER from 2.35% to 2.05%, and Overnight Repurchase Offer Rate from 2.25% to 2.00%.
  • The nature of this cut is widely described as “preemptive” or as “insurance” against the risks facing the economy, not pertaining to the decent performance of the economy itself. A 25 basis point cut leaves open the possibility of further easing in the near term should the economy show signs of needing a boost to sustain growth.
  • It will raise hopes that the FOMC is at the start of an easing cycle.

If the cut is 50 basis points:

  • A not insubstantial number of Fedwatchers are calling for the FOMC to reduce short-term rates by 50 basis points, arguing that more is needed to undo the negative effects of the rate hikes in 2018 and cushion against risks. I find it a hard argument to make since the economic data is not all that bad. Consistent growth of 2.0%-2.5% managed to produce an economy that built up to sustainable job growth and mildly firming inflation and led a period of synchronized global growth. Higher growth would of course be preferable, but unnecessary stimulus is more likely to lead to another boom-bust cycle than persistent – if unspectacular – improvement.
  • A 50 basis point rate action is associated with a crisis situation or a recession. That’s probably not a signal the FOMC wants to send. Right now, the available economic data just doesn’t look bad, especially for the labor market. Concerns about inflation running below the 2% objective aren’t seeing inflation measures materially softer after the undershoot in the first quarter, and core measures of indicators other than the PCE deflator do not suggest that the FOMC’s expectation for inflation to return to objective over the medium term is wrong.
  • A 50 basis point cut might also mean that the FOMC would be done cutting rates absent evidence of a significant downturn in the economy.

Since the last statement on June 19 and the meeting minutes:

The FOMC meeting statement set for release at about 14:00 ET on Wednesday, July 31 is going to have a lot of work to do if short-term rates are cut. It will have to justify its decision in light of the relatively better numbers about the economy against the “cross-currents” that led the Committee to downgrade its assessment last time around and the fact that a number of risks factors continue to linger, but only slightly manifest.

Chair Jerome Powell mentioned a number of data reports that would appear between his semiannual monetary policy testimony on July 10-11 and July 30-31. He already had in hand the June Employment Situation that put the softness in May in the rear view. Then there was a solid report on retail sales for June that placed consumer spending in a better light for the second quarter. Early July numbers for the housing market, and surveys of manufacturing and services pointed to an improved outlook after a wobble in June. The upshot is that things were starting to look better in June and have continued into July.

Balanced against this is still unsettled trade disputes with China, unresolved Brexit plans and no new Prime Minister, geopolitical developments such as confrontations with Iran, and generally sluggish economic conditions abroad. These are pretty much the same downside risks as have been in place for months and to which US businesses seem to have adapted for the moment.

Whether the FOMC decides to cut or not, or how much if they do cut rates, there will be no release of to the Summary of Economic Projections to help shape future expectations. That will not be officially updated until its regularly quarterly release at 14:00 ET on Wednesday, September 18. Thus, Fedwatchers are initially going to be reliant on what Powell has to say in his 14:30 ET press briefing on July 31, and eagerly await the end of the communications blackout period at midnight on Thursday, August 1 after which other policymakers will be free to comment.

As a footnote, at this meeting the FOMC will get the July edition of the Senior Loan Officer Opinion Survey. If it suggests that banks are tightening costs and availability of lending and/or if businesses and consumers are impacted negatively by higher borrowing costs and access to credit, it will be another argument in favor of a rate cut to ease conditions. The Fed normally releases the survey at 14:00 ET on the Monday following the meeting at which it is presented. However, it does not have an official release date.

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