October 31, 2019

Uncertainty has taken its toll on the global economy where the growth outlook has deteriorated as trade and geo-political tensions have intensified.  Manufacturing activity worldwide has been the most prominent casualty.  While the industrial and global business-spending slump appears to be deepening, the risk of a recession in the U.S. appears to be contained for the time being.  Nevertheless, risks to outlook are tilted to the downside and softer economic data indicate a downshift in economic activity.


Leading Economic Indicators GDP



Signs that the economy is experiencing uneven growth and losing some momentum piled up in broad-based September economic data.  While the unemployment rate fell to a five-decade low, other labor indicators, such as hiring plans and job openings, look as if they have topped out and indicate a slowing trajectory in hiring.  One month’s data point doesn’t make a trend but September’s retail sales disappointed with a surprising decline possibly signaling increased consumer caution, as, on paper, households are still in good financial shape, thanks to rising asset values, a high level of savings and growing incomes supported by a solid, if slowing, pace of job growth.  In another sign of increased caution, both big and small business surveys revealed that confidence is fragile and businesses are increasingly reluctant to make major spending commitments.  The Fed’s Beige Book, a compilation of anecdotal evidence in the various Districts, confirmed that activity had moderated as businesses trimmed their growth outlooks due to prolonged uncertainty.

Small and large Bus Optimism

The Beige Book also said prices had increased at a modest pace in most Districts, suggesting that the tame inflation trend appears to be well entrenched.  The strong dollar-cheap import prices make U.S. products less competitive on the world markets and constrains the pricing powers of domestic producers for domestic consumption.  With global aggregate economic growth and demand slowing leading to slack in capacity utilization and to more goods chasing fewer buyers, inflation expectations have moved to the lower end of historical ranges.  Although the core trend has shown some firming in recent months, it is still running below levels that would threaten the FOMC’s easing bias with some Committee members concerned that it may remain skewed to running too cool, not too hot.

Core Inflation

The Fed recognized the growing risks that uncertainty and deteriorating conditions overseas pose on the U.S.’s economic outlook, particularly the impact on business confidence and investment spending and the potential of the industrial slump spilling over into the broader economy.  The on-balance soft September economic releases set up the Fed to take additional “insurance” in the form of a 25 basis point rate reduction.  Coming into the meeting, policy makers had held the door open to cutting rates for a third time in as many meetings but, comments by some Fed officials suggest the policy move was not baked into the cake and they were uncomfortable with lowering interest rates with the unemployment so low and that “ultra-low” interest rates could have unintended consequences for financial instability by inducing investors to shift to riskier investment strategies lending to excessive risk taking.

Targeted Fed Funds

On October 30th, the Federal Open Market Committee elected to cut the targeted fed funds rate another 25 basis point to 1.50% - 1.75%, while continuing to emphasize risks to the outlook from global growth and acknowledging that inflation remains below target.  They made a similar reduction in the rate on Interest On Excess Reserves (IOER), bringing the rate down from 1.80% to 1.55%.  Uncertainties leading to bad outcomes worried the Fed, thus adding another ounce of prevention rather than a pound of cure.  The policy statement had the air of a compromise – the doves on the Committee got their rate cut and the hawks got a signal that the Fed could pause.  The Feds played their cards close to the vest on future rate actions.  The statement omitted the familiar statement “act as appropriate to sustain the expansion” in favor of “monitor the implications of incoming information for the economy as it assesses the appropriate path of the target range for the federal funds rate”, leaving the door slightly open for additional rate reductions, if needed.  Reinforcing the sense that the Fed would like to end the rate-cutting cycle, Fed Chairman Powell said that policy adjustments to date would provide support to the economy, citing that rates policy was accommodative and the fed funds rate adjusted for inflation was slightly negative.  He added the stance of policy was likely to remain appropriate but the Fed would respond if the outlook materially changed.  In sum, he raised the bar to make a policy adjustment either way.