Jim Palmer, Chief Investment Officer
The Federal Reserve Open Market Committee (FOMC) cut interest rates 25 basis points (bps) at the July 31st meeting. Coming into the meeting, a rate cut was virtually assured, with the only real debate whether it would be 25 or 50 bps. On July 18th, Federal Reserve (Fed) New York President Williams and Fed Vice Chairman Clarida trumpeted the benefits of acting quickly and aggressively when dealing with low inflation expectations. The market interpreted the comments - rightly in our mind - as a clear indication the FOMC was prepared to get aggressive and cut rates a full 50 bps. Incredibly, the New York Fed's spokesperson felt compelled to clarify Mr. Williams' comments as academic theorizing and not about expected policy action. Not the Fed's finest hour. Anyway, if the FOMC were truly preparing markets for a 50 bp rate cut, the New York Fed would have just let the comments stand. They didn't, so a 25 bp cut became the base case once again.
A few key points from the FOMC statement and Chair Powell's press conference:
- The federal funds target range was lowered 25 bps to 2.00% to 2.25%
- The interest rate on excess reserves was lowered 25 bps to 2.10%
- Balance sheet reduction will conclude August 1st, two months earlier than previously indicated
- The FOMC's rationale for cutting rates was based on "the implications of global developments for the economic outlook as well as muted inflation pressures"
- The FOMC vote was 8-2 for the policy change, with Fed Bank Presidents Rosengren and George preferring to maintain the 2.25% to 2.50% target range. There were no dissents favoring a 50 bp cut.
- In a low-key press conference, Chair Powell's tone was probably less dovish than market expectations. Mr. Powell suggested while there may be more rate cuts if warranted, the FOMC's actions were not the start of long rate cut cycle.
We agree with Mr. Powell's assessment that lowering the anticipated rate path eased financial conditions - and in turn almost certainly supported asset prices. Beyond that, I am skeptical how much impact these cuts will have on the economy. Monetary accommodation works best when dealing with recessions and stress in the banking system. With Chair Powell voicing an overall positive outlook on the U.S. economy and a banking system primed and ready to lend to worthy borrowers, the Fed is burning scarce ammunition to reinforce an already liquid lending market.
Unfortunately, the FOMC's decision probably won't satisfy the Fed's critics. Few Fed Chairs have faced the public rebukes suffered by Jay Powell at the hands of President Trump. Throw in financial market demands for accommodation in the face of trend U.S. GDP growth and a 3.7% unemployment rate and you have an FOMC dealing with some tough cross-currents. I'm not sure the FOMC's move from data-dependency to market-dependency will serve them well in the future.
Why? Because market-dependency really means the Fed must bow to market demands - and certain demands can never be satisfied. For example, as my wife and I transition to empty-nesters, we shower Zoey - our six-pound Morkie - with an outlandish amount of attention. Unfortunately, I got in the habit of dropping small bits of food off my plate when she begs. The results are predicable. Zoey now makes her demands without shame or remorse and basically no amount of food will satisfy her. I placate her because I want the howling to stop. Is the dilemma Jay Powell and the FOMC face that dissimilar? President Trump - predictably on cue - tweeted, "As usual, Powell let us down." Analysts and traders just shook their heads, dismayed the Fed failed to provide a clear path on inflation and future policy. But what they really wanted was assurance more rate cuts were on the way. Indeed, Mr. Powell's optimistic outlook and insurance rate cut did not satisfy the howling of the wolves. And really, what would have?
My best guess is...nothing. At least nothing reasonable. So, here's hoping Mr. Powell has the fortitude I so sorely lack and keeps the food on his plate until the markets are truly hungry.
Federal Reserve, FOMC Press Release, July 31, 2019
Federal Reserve, FOMC Press Release, June 19, 2019
Federal Reserve, Transcript of Chair Powell's Press Conference Opening Statement and Q&A, July 31, 2019
Financial Times, NY Fed Takes Unusual Step of Clarifying President's Speech, July 18, 2019
Twitter, @realDonaldTrump, July 31, 2019