After the FOMC meeting ended yesterday, the Fed announced a 25bp rate cut as widely anticipated and that it will end its balance sheet tightening earlier in August.
The Fed’s message also suggests another likely cut in Q4 2019, which Fed Chair Powell affirmed during his press conference by stating that “I didn’t say it’s just one” cut.
There were two dissenting votes by committee members Esther George and Eric Rosengren who favored keeping the Fed Funds rate unchanged.
While the Fed statement and Powell’s press conference were broadly in line with expectations, it was at the margin less dovish versus the aggressive market expectations of Fed action.
This resulted in a volatile recalibration in cross-asset markets overnight.
Before the FOMC, the markets were pricing in a small likelihood of a 50bp cut at the July meeting, and futures market pricing reflected expectations of as much as a 100bp decline in rates by 2020.
The language in the FOMC statement replaced “closely monitor” with “continue to monitor” in reference to incoming information for the economic outlook, and this suggests a slight toning down of the Fed’s risk-management activism.
Notably, Powell in his press conference also pushed back against the idea of a long series of rate cuts, and characterized this easing cycle as a “mid-cycle adjustment to policy”.
These were read by the market to be hawkish versus market expectations, and against this backdrop we were not surprised with near-term market volatility as overly aggressive expectations of Fed easing are reined in.
The 10Y treasury yield fell 4bp to 2.01%, while the US dollar appreciated (DXY index up 0.5%), which underlines the difficulty for the US in curtailing dollar strength.
In equity markets, the S&P 500 fell as much as 1.7% intraday and closed down 1.1%. At the time of writing, the Hang Seng index is down 0.2%.
Market expectations and pricing have by now rapidly adjusted, and the funds futures market is now reflecting a reduced 60% likelihood of a 25bp cut in September (and 85% by December).
We believe that Powell’s characterization of this easing cycle as a “mid-cycle adjustment” should not be interpreted as a one-and-done.
In 1995 and 1998 when we last saw mid-cycle adjustments to insure against downside economic risks, the Fed cut rates by a total of 75bp cuts in each episode, and this does not diverge too much from market expectations today.
The Fed is also consistent in its message that it remains vigilant against economic downside risks. Powell cited the Fed’s focus on multiple risks, including global growth, trade uncertainty, low inflation and US economic data, and should we see persistent trade uncertainty and manufacturing weakness in H2 2019, we will expect the Fed to continue in easing monetary policy.
Following this 25bp cut in July, another 25bp cut will likely follow sometime in Q4 2019, although a third cut will depend on further developments in trade and the economy.
We also expect rate cuts from other central banks in the next few months following the Fed, and note that some emerging market (EM) central banks, such as the Bank of Korea, Bank Indonesia and the South African Reserve Bank, have already moved ahead of the G3.
With our baseline scenario of synchronized global easing and a limited likelihood of a recession over 12 months, we believe the overall environment continues to be supportive of risk assets and recommend that investors remain engaged with markets.Disclaimer applicable to recommendation
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