September 30, 2019

The tug of war between U.S. economic resilience and external forces -slowing global growth, ongoing trade tensions and elevated geo-political risks - continued in September.  To buffer the domestic economy against those headwinds, the Federal Open Market Committee (FOMC) provided, as characterized by Fed Chairman Jerome Powell, another insurance rate reduction at the September 18 meeting.  It may have been a contentious decision as there were 3 dissenters, 1 for a 50 basis point rate cut and 2 who wanted to hold rates steady.  While leaving the door open to further rate cuts should the economy turn downward, there was no commitment.  The bulk of the FOMC, according to Powell at the post-meeting press conference, is taking decision from meeting to meeting.


Targeted Fed Funds



In addition to lowering the targeted federal funds range by 25 basis points to 1.75% to 2.00%, the FOMC cut its interest rate paid on overnight required and excess reserves by 30 basis points to 1.80%.  This was intended to foster trading in the fed funds market at rates well within the FOMC’s target range.  This comes amid dislocation and a temporary imbalance in the market that had repo pushed short-term financing rates higher.  The policy statement’s assessment of current economic conditions relatively unchanged, noting strength in household spending but weakening in business investment and exports.  In the accompanying Summary of Economic Projections, the dot plot signaled that there are 3 distinct camps within the Fed.  The median of the interest rate projection imply no further in change in the fed funds rate for this year and next.  However, there is a wide dispersion in the range of rate forecasts.  One faction thinks sufficient pre-emptive easing has been delivered and another faction believes the Fed needs to do more to mitigate downside risks.  Finally, there’s a group that accommodation is unnecessary.

FOMC Year End Projections

The U.S. economy may be losing some momentum but it is far from the dire straits seen overseas.  Historically, deteriorating economic conditions in Europe and Asia have not led to recessions in North America.  It usually flowed the other way – “When the U.S. sneezes; the rest of the world gets a cold.”  However, further weakening in foreign demand and trade flows could act as a restraint on U.S. growth and continue the strengthening in the dollar.  This has primarily been reflected in the U.S. manufacturing sector.  Having said that, recent data exceeded expectations but some recent events, such as hurricane Dorian, tropical storm Imelda and the GM strike, have yet to be incorporated and reflected in the data.

Economic Activity and Real Interest Rates

Given the erratic path of trade negotiations seen over the past year, it is extremely difficult for businesses to have confidence to make decisions and investments.  To date no off-ramp has been found in the trade tensions between China and the U.S.  Moreover, other geo-political risks (Brexit, Iran, Hong Kong, etc.) and political risks (impeachment inquiry) have moved back to the forefront.  Unfortunately, these risks and recent weather-related and labor strike events will make a clear read on the data difficult in upcoming months.  The only thing in concrete is the Fed’s promise that, if needed, will adjust policy to sustain the longest economic recovery on record.  The market is priced to reflect that the Fed will have to make good on that promise.