Jim Palmer, Chief Investment Officer
The Federal Open Market Committee (FOMC) cut the federal funds target range 25 basis points (bps) at the October 30th meeting. The ease itself was not surprising (pre-meeting, futures placed a 97.1% probability on a rate cut), although street speculation whether a cut was warranted was higher than for previous meetings. I view this as a good sign. While I have been pushing for the Fed to stand tall and hold its ammo, I was rooting for this cut as a necessary step in getting on a faster track toward markets asking whether the Fed has overreacted and eased too much. Such an environment would likely promote a steeper yield curve over time and allow banks to lend more profitably, creating a virtuous cycle of increasing capital bases and loan books - which I view as a more efficient form of stimulus than lower rates.
Key details from the Fed's October 30th meeting:
- The federal funds target range was lowered 25 bps to 1.50% to 1.75%
- The interest rate on excess reserves and overnight reverse repos was lowered 25 bps to 1.55% and 1.45%, respectively
- The FOMC voted 8-2 for the policy change. Fed Bank Presidents Rosengren and George preferred to maintain the current target range. After dissenting for a 50 bp cut at the September 18th meeting, Fed President Bullard voted with the majority for a 25 bp cut.
- The Fed dropped "will act as appropriate" from its statement in favor of "assess the appropriate path of the target range." The subtle difference signaled a greater willingness to pause rate cuts, which is in line with Chairman Powell's belief recent actions were mid-cycle adjustments rather than the beginning of a sustained easing path.
- During his press conference, Chairman Powell stated the current stance of monetary policy is likely to remain appropriate, but the Fed would respond if its outlook changed materially. When pressed by a reporter, the Chairman was rather coy about what would constitute a material change.
The base case now has to be for a pause at the December 11th meeting. What would constitute a material change? A No-Deal Brexit? Maybe, but the risk is lower and basing policy on politics is a fool's errand. A further slowdown in business investment? Probably not - the Gross Private Investment component of GDP has already slipped into recession with growth rates of -1.5% and -6.3% the past two quarters and the Fed still signaled a pause. A convincing slump in employment conditions? That would qualify but is highly unlikely to happen in the next seven weeks. Stock market volatility? Meltdown = yes, minor correction = no. The Fed has signaled a pause and can't afford to look too beholden to equity markets. Further trade tensions? Nope, I sincerely doubt the Fed has a trade deal baked into the its forecast.
Where are we with Balance Sheet and Repo Management?
- In order to maintain ample reserves in the banking system, the Fed is purchasing $60B in T-Bills per month at least into the second quarter of 2020. T-Bills with remaining maturities greater than 4 weeks to 1 year are eligible.
- T-Bill purchases are in addition to ongoing purchases of Treasury securities related to the reinvestment of principal from agency debt, agency MBS and maturing Treasuries
- Monthly agency principal payments up to $20B are reinvested in Treasuries roughly matching the maturity composition of outstanding Treasuries. Principal payments in excess of $20B will be reinvested in agency MBS.
- Treasury maturities are reinvested proportionally in new Treasuries auctioned around that maturity date
- To mitigate the risk of money market pressures, the Fed is offering at least $120B in overnight repo operations and at least $35B in 14-day term operations. Term operations have been temporarily increased to at least $45B to span the October month-end period. These open market operations will be conducted at least through January 2020.
I understand the balance sheet details are a bit wonky. But let's face it, if you're reading this piece you probably dig monetary policy minutia. I do, especially when it makes my life easier. The Fed clearly does not want a repeat of the mid-September spike in repo / SOFR levels and is flooding the market with ample liquidity. While there may be small rate spikes around sensitive dates (month end, year end, refunding dates), more 300 bps jolts are unlikely.
Federal Reserve, FOMC Statement, Press Conference and Implementation Note, October 30, 2019
Federal Reserve Bank of New York, Statement Regarding Treasury Bill Purchases and Repurchase Operations, October 11, 2019
Federal Reserve Bank of New York, Statement Regarding Repurchase Operations, October 23, 2019
Federal Reserve Bank of New York, FAQs: Treasury Reinvestments - Rollovers, July 31, 2019
Federal Reserve Bank of New York, FAQs: Treasury Reserve Management and Reinvestment Purchases, October 16, 2019