As widely expected, the Fed cut the fed funds rate on Wednesday by 25bp to a target range of 1.75% – 2.0%.
The divide within the FOMC grew clearer at this latest meeting with three dissenting voters, versus two in July. George and Rosengren voted to have no cut, as they did in July, while Bullard emerged as a dovish dissenter and voted for a deeper 50bp cut.
This wider dispersion of views in the committee was apparent in the latest dot plot as well. Overall, the updated dot plot was somewhat more hawkish versus expectations. While seven participants see a third cut in 2019, five participants see no more cuts, and five indicated that no change would have been appropriate in September – which points to a median rate of 1.875% by end 2019.
During his post-meeting press conference, Fed Chair Powell focused on projecting optimism about the economy, and reiterated that the Fed stands ready to ease further to sustain the expansion if needed.
Although he again cited global growth and trade conflict as risks to the expansion, there was a conspicuous lack of commitment to further cuts - which signals a data-dependent approach ahead.
After an initial knee-jerk sell-off due to Powell’s less dovish than expected press conference, the cross-asset landscape surprisingly staged a classic risk-on move: US equities rallied, Treasury yields rose, while safe havens such as the Japanese Yen and gold depreciated.
Considering the market’s limited reaction to the ECB’s easing package last week, which was also less dovish versus expectations, and to the attacks in Saudi Arabia over the weekend, we believe these recent market moves underline how investor sentiment has turned more benign in response to: 1) a more positive tone in the US-China trade talks and rising expectations of a mini-deal; 2) global manufacturing PMIs exhibiting some nascent signs of stability while the service side of the global economy and consumer confidence remain fairly resilient; and 3) increasing optimism that the US will avoid a recession.
The last point, in particular, was reinforced by the Fed’s more confident tone at this meeting and the surprising upgrade of its median forecasts of US real GDP growth from 2.1% to 2.2% for 2019F and 1.8% to 1.9% for 2021F.
Our baseline scenario is that the Fed would make one to two more 25bp cuts over the next 12 months as structural risks persist while investor sentiments would ebb and flow over this period. Granted, there are concerns about the divided committee, but a firm majority of seven members is signaling one more cut for this year and appears to be solidly behind Powell. As for the dissenters, Bullard stands at the dovish end of the committee, and we see limited likelihood of more members joining the two hawkish dissenters.
We continue to prefer a slightly underweight risk exposure in our asset allocation strategy given structural downside risks posed by persistent US-centric trade policy uncertainties, rising geopolitical tensions in the Middle-East, a still muddled global economic outlook, and uncompelling valuations. But we are not expecting a crisis-like market draw-down ahead: ultimately, we believe the global economy will bend and not break, and from our vantage point, the odds of a global recession in the next 12 months still seems less than even.Disclaimer applicable to recommendation
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