Optionality Successfully Maintained

The outcome of today’s FOMC meeting didn’t substantially change our views on the outlook for policy. We read the FOMC as trying to preserve optionality for September, and we think they achieved that. The market reaction was pretty benign, about as good as the FOMC could have hoped for: The somewhat lower market-implied probability of a September cut (still above 50%, however) and a relatively modest decline in equities,  on the net. Our call remains that the FOMC will cut rates by a further 25 basis points this year but that there are better-than-even odds that such a cut will come later than September. 

Statement and Policy Decisions 

Today’s FOMC statement and policy decisions were in line with our expectations: 

▪ Cut funds rate target 25 basis points 

▪ Not much change to first paragraph (incoming data) 

▪ Guidance in the second paragraph preserved optionality for September: Indicated willingness to cut further,  but without further fueling expectations of a September cut. 

▪ Two dissents (one more than expected) 

▪ Earlier conclusion to balance sheet runoff (details at the end of this note) 

The FOMC appears to have designed the guidance in the statement to preserve optionality for September, as we expected. In doing so, the guidance in the second paragraph went a bit further than expected—mainly by adding a reference to “global developments”—but in any case, the immediate market response to the statement seems to be one that would have pleased the FOMC. The market lowered the probability associated with a further 25-basis-point cut in September, but not drastically—to a level still above 50%. There was a  slight decline in the S&P 500 when the statement came out. At the end of this document is a comparison of the July FOMC statement with the previous post-meeting statement. 

One interesting change was the use of “contemplates” to describe the Committee’s decision-making. Their convention is to use “considers,” which is very neutral. In contrast, to contemplate means to consider over a lengthier period. Perhaps the intent was to impart less urgency to further easing. 

Press Conference 

In his press conference, Powell for the most part stuck to a simple message about three factors that are key to both the rationale for this easing and the prospects for future easing: “The Committee is really thinking of this as a way of adjusting policy to a somewhat more accommodative stance to further the three objectives that I mentioned: to insure against downside risks, to provide support to the economy, that those factors are pushing down on economic growth, [and] to support inflation. We do think it will serve those goals. We’re  thinking of it in the nature of a mid-cycle adjustment to policy.” 

This shift in policy was about both changes in the baseline outlook and risks to the baseline outlook: “I gave three reasons for what we did — that is to insure against downside risks to the outlook from weak global growth and trade tensions. That is a risk management point. And that is a bit of insurance. But we also feel  

like weak global growth and trade tensions are having an effect on the U.S. economy…And also to support the return of inflation to 2%. But there is definitely an insurance aspect of it.” He also cited, without being asked,  the decline in the NAIRU as another argument for more accommodation. 

Powell was asked essentially the same question repeatedly: When and how will the FOMC ascertain if additional easing is needed? Powell did not want to comment explicitly on whether there would be further easing or on the timing. He said the FOMC would continue to look at the factors that had prompted the FOMC  to cut rates at this meeting: “Going forward, I would say, we’re going to be monitoring those same things.  We’ll be monitoring the evolution of trade uncertainty, global growth, and of low inflation. And we’ll also  be watching the performance of the U.S. economy.” 

Powell pushed back against the idea that this rate cut meant many additional rate cuts would follow, while at the same time leaving the door open for further action. This was especially interesting given that the June dots showed that seven FOMC participants expected 50 basis points in cuts to be appropriate by the end of the year, and many participants seemed to concur in their individual remarks. He drew a distinction between  this cut and the prospect of a “lengthy cutting cycle,” which he described as “referring to what we do when  there’s a recession or a very severe downturn.” Rather, he presented this cut as a “mid-cycle adjustment to policy” and pointed to previous examples of so-called insurance cuts, presumably those of the mid-1990s.  He elaborated, “I said it’s not the beginning of a long series of rate cuts. I didn’t say it’s just one or anything like that. He elaborated, “I said it’s not the beginning of a long series of rate cuts. I didn’t say it’s just one or anything like that. 

Of course, he was careful not to completely dismiss the possibility that a full easing cycle might be needed,  noting that, “I don’t know that [previous insurance cut cycles will] be comparable.” But at this juncture, the  FOMC’s baseline case is that “it’s appropriate to adjust policy to a somewhat more accommodative stance  over time.” He just wanted to be clear that the motivation for the July cut was not the perception of a severe economic slowdown. 

However, he also made clear that there being an “insurance” element to this cut did not imply that the FOMC  was thinking about reversing the cut. As part of a response on a separate topic, he noted that “long U.S.  business cycles have sometimes involved this kind of event where the Fed will stop hiking, will cut, and go back to hiking. I don’t know whether that will happen here. It doesn’t seem like something that’s, you know,  particularly likely, frankly.” 

Dissents 

There were two dissents. Rosengren and George both preferred not to cut the funds rate at this meeting. Balance Sheet Policy 

The FOMC decided to terminate runoff immediately so balance sheet policy would not counteract the fund’s rate policy. This was not a surprise to us. In contrast, the original plan (from March 2019) was to conclude runoff at the end of September. Powell noted that the earlier end was “a matter of simplicity and consistency.” 

Treasury Reinvestments – Rollovers 

For the purposes of rolling over maturing Treasury securities, the New York Fed will continue to allocate purchases proportionally across securities being newly auctioned by their offering amounts. 

Treasury Reinvestments – Purchases 

Treasury reinvestment purchases associated with reinvesting agency debt and MBS principal payments will be in the secondary market and allocated across eleven different sectors that are approximately proportional to the 12-month average of the amount outstanding in each sector relative to the total amount outstanding, as of the end of July 2019.

These buckets have not changed since we reported on the relevant New York Fed announcement at the end  of May: 

IOER 

There was no additional adjustment to IOER beyond the corresponding 25-basis-point downward shift in accordance with the fund’s rate cut.  

Changes to the FOMC Postmeeting Statement (July vs. June) 

Information received since the Federal Open Market Committee met in June May indicates that the labor market remains strong and that economic activity has been rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although the growth of household spending has appeared to have picked up from earlier in the year, indicators growth of business fixed investment has have been soft. On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation remain low 

have declined; survey-based measures of longer-term inflation expectations are little changed. 

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. The Committee continues to In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective areas the most likely outcomes, but uncertainties about this outlook remain. 

have increased. As the Committee contemplates the future path of the target range for the federal funds rate, In light of these uncertainties and muted inflation pressures, the Committee will continue to closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective. 

In determining the timing and size of future adjustments to the target range for the federal funds rate, the  Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range 

of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. 

The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market  Account in August, two months earlier than previously indicated. 

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice-Chair; Michelle  W. Bowman; Lael Brainard; James Bullard; Richard H. Clarida; Charles L. Evans; Esther L. George; and Randal  K. Quarles.; and Eric S. Rosengren. Voting against the action were Esther L. George and Eric S. Rosengren,  who preferred at this meeting to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. was James Bullard, who preferred at this meeting to lower the target range for the federal funds rate by 25  basis points. 

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