June 30, 2019

During the first six-months of 2019 the financial markets have progressively priced in a growing certainty the Fed would aggressively cut rates in the second half of the year.  The fixed income market increasingly discounted a hard landing for the economy, highlighted by plunging bond yields and a partially inverted yield curve. The markets’ view of the economy as a glass half empty, has it expecting the Fed to refill the punch bowl and soon.


Stocks vs 10 Yr TNote


Until recently, the Fed saw the economy as a glass half-full and was willing to keep rates on hold “for some time”.  Some signals, however, suggest that downside risks are rising.  Market volatility, geo-political and trade uncertainty, persistence of low inflation and weak readings in some key economic indicators led to Fed Chair Jerome Powell and Vice Chair Richard Clarida to suggest in early June that the Fed would take “appropriate” actions to sustain the expansion.  Trade tensions are weighing on the manufacturing sector as uncertainty cause businesses, especially those with meaningful export exposure, to delay capital expenditures.  A soft May employment report, tame inflation readings, along with falling consumer and market-based inflation expectations, reinforced investors bets of aggressive rate cuts.

Manufacturing Inventory

The mixed data likely gave the Fed a hard time reading the economy’s strength and momentum as they approached the June 18-19 FOMC meeting.  Many other labor indicators continued to show a great deal of strength.  The latest Beige Book, prepared for this meeting, showed a slight improvement in economic activity.  Consumers, the economy’s main growth driver, are still doing the heavy lifting by spending in April and May, giving the Fed some breathing room to stay the course for now.

Retail Inventory

At that meeting, the FOMC voted to leave the target fed funds rate unchanged at 2.25% to 2.5%, although there was one dissenter in favor of a 25 basis point reduction.  The Committee dropped “patient” from the description of its policy stance in their statement and emphasized that “uncertainties” in the outlook had increased.  “In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”  Even while striking an easing bias, the Fed will remain data dependent.  The Summary of Economic Projections (SEP), the “dot plot” revealed that median dot level had gravitated downward.  Even as the 2019 median dot held steady, eight of the seventeen members were leaning toward a rate reduction.


A growing consensus of traders, economists and analysts believe a 25 basis point rate reduction is more than likely at the July 30-31 FOMC meeting.  Their base rate argument is the Fed needs to act to keep from falling behind in its goal in sustaining the longest U.S. economic recovery on record.  Arguments for the Fed not taking pre-emptive policy action are the central bank has a limited amount of rate cuts before hitting zero, the credit channels remain largely unaffected, and the credit spread and financial conditions indexes are not indicating market distress.  Additionally, the Fed remains cognizant the additional accommodation can lead to unwarranted risk-taking and inflate asset bubbles.  Still, the Fed seems leaning further toward give the markets one, or possibly two, quarter point rate cuts over the course of the second half of the year to counter the rising level of uncertainties facing the economy and financial markets. Stronger action would appear to require an external shock or deterioration in market conditions or incoming data, but an insurance cut seems to be becoming increasingly likely.