The third Rate Cut By Year-End, “Organic” Balance Sheet Growth Soon

Last week’s FOMC meeting didn’t change our views on the outlook for Fed policy—at least the rates side.  We still see better-than-even odds that the FOMC will cut rates one more time this year, but we see this as more likely to come at the December meeting than in October (see our commentary on last week’s meeting).  As for balance sheet policy, we now see a very real chance that the FOMC will announce asset purchases at the October meeting, and whether they do will depend on what happens in money markets over the next few weeks. 

Over the last week, money market tightness has returned to the forefront of discussions of Fed policy. In response to pressure on money market rates, the New York Fed has conducted daily overnight repos and most recently announced several 14-day term repo operations. In addition, the FOMC lowered both the IOER  rate and the ON RRP rate by another five basis points relative to the fed funds target range. The official line has been that the pressure is related to recent tax payments and therefore likely to be transitory, and the actions are already taken have succeeded in bringing the effective fed funds rate back below the upper bound of the target range. However, Powell said at his press conference that the Fed would provide a “sufficient supply of reserves” so that “frequent” operations are not required. He suggested that the FOMC would consider the  issue at the next FOMC meeting and said, “There’s real uncertainty and it is certainly possible that we will  need to resume the organic growth of our balance sheet earlier than we thought.” We don’t see these  developments concerning money markets and the prospects for the balance sheet as affecting the outlook  for rates policy—consistent with Powell’s assurance that they have “no implications for the economy or the  stance of monetary policy.” 

Policymaker Remarks 

A couple of dissenters explained their disagreement with the FOMC’s most recent policy decision. Bullard  (Sep. 20) wanted a 50-basis-point cut. He said: “Lowering the target range for the federal funds rate by 50  basis points at this time would provide insurance against further declines in expected inflation and a slowing  economy subject to elevated downside risks.” Rosengren (Sep. 20) wanted no rate cut. He said: “While risks  clearly exist related to trade and geopolitical concerns, lowering rates to address uncertainty is not costless,”  and “Additional monetary stimulus is not needed.” He cited financial stability risks as a cost of lowering the fund’s rate. 

Clarida (Sep. 20) gave an interview Friday morning. He maintained an upbeat tone but warned “there’s a  broader global slowdown. There is a slowdown in global capital spending and global manufacturing” and  “certainly relative to where we were at the beginning of the year, I think they’ve been getting worse.” He  cautioned: “I’m not surprised by the resilience, but we don’t take it for granted either.” 

Kaplan (Sep. 20) said: “I’m open-minded but agnostic about whether there’s a need to do something more.  I’m going to be highly vigilant.” He reiterated that waiting for the consumption data to weaken means “we’ve  waited too long.” He elaborated: “My concern is if I knew the consumer was going to stay strong I would  come to one conclusion, but my concern is that weakness will seep into other parts of the U.S. economy.” 

The question of reserve scarcity emerged again as repo rates surged. As a result, the NY Fed resumed daily repo operations and announced a new series of both term and overnight repos. Williams (Sep. 20) noted that  “The thing we need to be focused on today is not so much the level of reserves. It’s how does the market  function.” SOMA Manager pro tem Logan (Sep. 20) added, “Reserves are concentrated, the excess reserves relative to the minimum level each bank is demanding is concentrated. And the key question is how those  reserves, as the level was coming down, would get redistributed, and how smooth that redistribution process  would be.” 

Clarida reiterated that the so-called “organic” balance sheet expansion would be on the agenda of the October  meeting (no later) and stressed that such purchases wouldn’t be “QE.” Rather, they would be in line with  “central banking 101,” and he pointed to the Fed’s actions with its pre-crisis balance sheet. Bullard thought the Fed was still in “ample reserves” territory. Rosengren went furthest in classifying the current situation as  “reserve scarcity”—that is, no longer ample. Money market strains are a “short-run, not a long-run, problem.”  He wanted “to move towards much more of a buffer than what we have, and you do that by expanding the number of securities that you’re holding.” Kaplan acknowledged the Fed was learning that demand for reserves was higher than anticipated, and he hinted the Fed should simply let the balance sheet expand at the pace of currency growth.  

Nowcasts (2019:Q3) 

Source Current One Week Ago Two Weeks Ago
Atlanta Fed GDPNow 1.9% 1.8% 1.8%
New York Fed Staff Nowcast 2.2% 1.6% 1.6%
CNBC/Moody’s Survey 2.0% 2.0% 2.0%

Recent Data 

The incoming economic data over the last week have largely been positive. The industrial production report for August was much stronger than expected, providing some reassurance after the ISM manufacturing survey had previously pointed to a contraction in the manufacturing sector in August. Overall industrial output rebounded 0.6% in August, easily beating consensus expectations. Manufacturing was strong, with a gain of 0.5% in August more than reversing the decline in output in July. Several releases boded well for residential investment. Homebuilder sentiment increased in September, and it’s been on an upward trend this year since bottoming out late in 2018. Both starts and permits posted very strong gains in  August. While those gains were boosted by strength in the multifamily category—which tends to be highly volatile—there were very solid gains in the single-family category as well for both starts and permits. Single 

family starts and permits have both picked up over the last several months. Finally, existing home sales advanced in August as well. Like many other housing-related series, existing home sales have also firmed up somewhat this year after weakening over 2018.

Release Period Actual Consensus Revision to  Previous ReleasePreviously  Released Figure
Industrial Production MoM Aug 0.6% 0.2% -0.1% -0.2%
Manufacturing (SIC) Production MoM Aug 0.5% 0.2% — -0.4%
Capacity Utilization Aug 77.9% 77.6% — 77.5%
NAHB Housing Market Index Sep 68.0 66.0 67.0 66.0
Building Permits MoM Aug 7.7% -1.3% — 8.4%
Housing Starts MoM Aug 12.3% 5.0% -1.5% -4.0%
Existing Home Sales MoM Aug 1.3% -0.7% — 2.5%
Markit US Manufacturing PMI Sep P 51.0 50.4 — 50.3
Markit US Services PMI Sep P 50.9 51.4 — 50.7
Markit US Composite PMI Sep P 51.0 — — 50.7

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