On Thursday afternoon, both Vice Chair Clarida and New York Fed President Williams strongly indicated that there will be a rate cut at the July FOMC meeting. That we already knew. But the dovishness of their remarks—and especially the context—suggest that the cut will be 50 basis points instead of 25 basis points. Our call is now that the FOMC will cut rates 50 basis points at the July FOMC meeting. It seems we have more conviction in this view than the market, which even after today’s remarks is still pricing in a roughly one-in-three chance of a 25-basis-point cut.
When we say the context of their remarks is crucial to interpreting the intended message, we mean the state of market expectations. Before their remarks today, the market was unsure about whether the July cut would be 25 basis points or 50 basis points. They could have left it that way. Williams’ and Clarida’s appearances today appear to be a coordinated effort to push market expectations to price in a larger cut more decisively. This reminds us of the intervention by President Dudley in early 2017 to signal strength to the market that a March 2017 hike was a done deal.
Even if Clarida and Williams didn’t intend this as a coordinated signal (an exceedingly unlikely scenario), the key point is that it may not matter: The result is that the market now sees a 50-basis-point cut as much more likely than a 25-basis-point cut. As we wrote in a note earlier today, the Fed may be okay with disappointing markets slightly, but it doesn’t want to disappoint with a smaller cut when markets see the odds as so significantly favoring a larger one (as a result of their encouraging expectations of a larger cut!). Tomorrow is the last day before the blackout period for communications begins, and we see very little prospect of key FOMC policymakers returning to the airwaves to talk back down the prospects of a larger cut.
Now we turn to their actual remarks, which were unequivocally dovish. Clarida doesn’t seem to have been phased by a firmer CPI report since the June FOMC meeting. He said that inflation has been on the “soft side” and that disinflationary pressures “if anything is more intense than I thought six weeks ago.” Williams also signaled concern about the inflation outlook, with a particular emphasis on inflation expectations. He said that soft inflation expectations were “somewhat worrisome given the otherwise strong U.S. economy.” He alluded to sluggish inflation compensation implied by prices for TIPS: “Investors are increasingly viewing these low inflation readings not as an aberration, but rather a new normal.”
Both Williams and Clarida emphasized that policymakers should lean toward providing accommodation earlier and in larger doses. Williams said there was no good reason to wait to ease: “Don’t keep your powder dry.” He advised policymakers to “take swift action” when faced with adverse economic conditions. Clarida quoted Williams directly later in the day: “As [Williams] indicated, you don’t want to wait until the data turns decisively if you can afford to.” In case the message wasn’t clear enough, Clarida repeated it: “If you need to use it, you don’t need to wait until things get so bad to have a dramatic series of rate cuts.” Rather, decisions must be made “based upon where we think the economy may be heading and, importantly, where the risk to the economy is lined up.” That means it can be appropriate to “take out insurance policies in good times.” He called that “part of the toolkit.”