Only Question Now Is How Large of A Cut

The June FOMC minutes reinforced our conviction that the FOMC will cut the fed funds rate at its July 31  meeting. Much as Powell did at his post-meeting press conference, these minutes suggested that at the June  FOMC meeting participants were strongly inclined to ease policy in the near term and that a primary reason they didn’t go ahead and cut immediately was simply the recency of various developments. While the minutes didn’t explicitly mention the timing of a possible cut (e.g., July vs. September), the overwhelming sense was that six more weeks—the amount of time until the July meeting—would be enough of a wait. We see that as  consistent with Powell’s testimony earlier today, in which he no longer talked about the recency of certain  developments and chose not to push back whatsoever on market expectations that a July rate cut is a near 

certainty. 

We see almost no chance that incoming information before the month-end FOMC meeting will keep the FOMC  from cutting rates. The question now is: 25 basis points or 50 basis points? At his press conference in June,  Powell said the FOMC hadn’t discussed that issue, and the minutes confirmed that that was the case. In addition to having greater conviction in our call for a July rate cut, we also see a slightly higher chance that the easing could be 50 basis points rather than 25 basis points. The widely shared anxiety in the minutes about downside risks to inflation, inflation expectations, domestic investment, and global growth could encourage the Committee to consider the benefits of a larger cut. The fact that markets are anticipating a  50-basis-point cut is also relevant, and in this context, this line from the minutes was particularly notable:  “While overall financial conditions remained supportive of growth, those conditions appeared to be premised  importantly on expectations that the Federal Reserve would ease policy in the near term to help offset the  drag on economic growth stemming from uncertainties about the global outlook and other downside risks.”  But we think the main takeaway from that line is that the FOMC is likely to cut; we don’t think the market would necessarily react so harshly to the first cut being only 25 basis points, especially when the FOMC is signaling a willingness to ease further. Note that Bullard (who dissented in June in favor of a cut) has repeatedly advocated for the first cut to be only 25 basis points despite his baseline including another 25- basis-point cut later in the year. Our call remains that the first cut will be 25 basis points, with a 50-basis 

point cut perhaps signaling more alarm than the FOMC would want. 

The dots and macro projections released immediately after the June FOMC meeting showed that the FOMC  had become significantly more pessimistic about the outlook, and the additional detail provided in these minutes and the full Summary of Economic Projections reinforce that message. “Many,” thought the economy  had lost momentum since the May meeting, pointing to factors such as “recent weak indicators for business  confidence, business spending and manufacturing activity; trade developments; and signs of slowing global  economic growth.” “Many” saw risks to the growth and inflation outlook as “shifting notably over recent  weeks” so that they had become “weighted to the downside.” The scope and persistence of the current yield  curve inversion clearly caught the attention of policymakers, and during their discussion of the decline in  longer-term yields “several noted that their assessment of the risk of a slowing in the economic expansion  had increased based on either the shape of the yield curve or other financial and economic indicators.” The labor market and consumer spending were two areas not on the list of primary concerns. It was noted that  

the May jobs report was weaker than expected, but the consensus was that “conditions remained strong” in the labor market. Data on consumer spending had been “solid” 

While moves in the dots and macro projections were substantial if anything they understated the change in the outlook. Those projections show the scenarios that each policymaker assesses as most likely. Today we learned that, even after substantially revising their baseline scenarios, “many” assigned “significant odds” to less favorable scenarios. Most saw risks to their growth and inflation projections as weighted to the downside;  likewise, a clear majority saw the risks to their unemployment rate projections as weighted to the upside. 

In addition to all of the concerns about the outlook on the real side, the discussion on the inflation outlook was particularly sobering. Both headline and core inflation had disappointed in recent months. Furthermore,  “In light of recent softer inflation readings, perceptions of downside risks to growth, and global disinflationary pressures, many participants viewed the risks to the outlook for inflation as weighted to the downside.” They still anticipated that headline inflation “would firm somewhat and move up to the Committee’s longer-run symmetric objective of 2 percent over the next few years,” which doesn’t sound like a very satisfactory outlook. “Several” participants commented that measures like the Dallas Fed trimmed-mean inflation rate  “were running around 2 percent,” but that argument has clearly lost weight. It was followed by this line:  “However, a number of participants anticipated that the return to 2 percent would take longer than previously  projected even with an assumed path for the federal funds rate that was lower than in their previous  projections.” 

The worry about inflation expectations slipping had clearly escalated substantially. Market-based measures  of inflation compensation “had declined and were at low levels.” “Some” participants also noted that “recent  readings on some survey measures of consumers’ inflation expectations had declined or stood at historically  low levels.” “Many” noted that longer-term inflation expectations “could be somewhat below levels”  consistent with 2% inflation, or that persistently soft inflation could “further” erode expectations: “These  developments might make it more difficult to achieve their inflation objective on a sustained basis.” 

With all of these negative developments since the previous FOMC meeting, there was clearly a strong bias toward easing policy. Policymakers generally agreed that downside risks had intensified and “many  participants indicated that the case for the somewhat more accommodative policy had strengthened.” Almost half (eight out of 17) saw easing by year-end as appropriate in their baseline outlook. And, as Powell indicated during his press briefing, this understates the disposition that policymakers had toward easing in the near term. As Powell mentioned, even a number of those who did not project 2019 easing in their dots were sympathetic to this argument. 

While only two (likely Bullard and Kashkari) wanted an immediate rate cut, it seems that the recency factor was all that held others back from supporting a June rate cut. Many of the developments leading them to  consider easier policy “were quite recent,” but “Many judged additional monetary policy accommodation  would be warranted in the near term should these recent developments prove to be sustained and continue  to weigh on the economic outlook.” That is about as strong a statement about the prospects of a near-term easing as the minutes could offer. In addition, “several others”—presumably members of the group that didn’t  have a cut in their dots—thought easing “could well be appropriate if incoming information showed further  deterioration in the outlook.” 

The minutes provided a laundry list of factors supporting a lower path of the fund’s rate (not necessarily an immediate cut). “Several” cited risk-management thinking (insurance cut logic), the appeal of cutting to “help  cushion the effects of possible future adverse shocks.” “Some” fretted over the passthrough from soft inflation to lower inflation expectations. “Several” had lowered their NAIRU estimates and saw less upward pressure on inflation as a result. “A few” worried inflation expectations had already fallen below levels consistent with 2% and thought easing was warranted as a result. And “a few” thought that given the symmetric nature of the inflation objective it might be desirable to have inflation run above 2% for some time for the sake of credibility.

The “hawkish” case presented in the minutes was hardly hawkish at all. “Some” had flattened their policy assumptions but deemed that there was “not yet” a strong case to cut. They wanted more time to assess.  “A few” saw the economy as “still in a favorable position in terms of the dual mandate” and worried that  easing to achieve higher inflation “risked overheating the labor markets and fueling financial imbalances.” And  only “several” cited the trimmed-mean inflation measure as supporting the logic that soft inflation is merely  “transitory.” 

Standing Repo Facility 

Separately, there was some progress made on the issue of a standing repo facility, some form of which we ultimately expect will be implemented. Although no decisions were made at the June meeting, the focus on this topic suggests that this initiative is now a priority for the Fed and the FOMC as the end of runoff approaches and in order to maintain sufficient control over the fed funds rate. 

A key issue is how to set the level of the repo rate relative to market rates. The sweet spot seems to be a  moderate spread above money market rates. Setting excessively high repo rates would erode the Fed’s control over interest rates and exacerbate the potential stigma of using the facility. Setting repo rates too close to  prevailing market rates “could result in very sizable Federal Reserve operations on a daily basis that could be  viewed as disintermediating the activity of private entities in money markets.”There was also debate over the scope of counterparties and collateral eligible for the facility, with numerous tradeoffs cited. 

Policymakers seemed open to such a facility despite some reservations, but many fundamental questions remained unsettled, and they don’t seem close to a final decision. First of all, they wanted to delineate the policy objectives. Some noted that a facility might be redundant if reserves remain ample, but others thought even with ample reserves having this option would enhance control and limit volatility in repo rates. Several hinted that a standing repo facility might “possibly aid with multiple policy objectives,” which could be a reference to the Fed’s financial stability and regulatory roles. Several also raised questions about moral hazards and losing control of the balance sheet. All in all, the establishment of a standing repo facility still seems plausible but is by no means a done deal. 

Framework Review Update 

Clarida reported on the numerous “Fed Listens” events since January. More events are planned through year-end, but the FOMC will “begin internal deliberations on aspects of the strategic review” over the coming  FOMC meetings.

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