The Fed is expected to cut rates, but how Powell discusses the next move could rattle markets
Federal Reserve Chairman Jerome Powell holds a news conference following a two-day Federal Open Market Committee meeting in Washington, June 19, 2019.
Kevin Lamarque | Reuters
Federal Reserve Chairman Jerome Powell faces one of the more difficult communications challenges of his tenure Wednesday, and he risks spooking financial markets if he doesn’t get it just right.
The Federal Open Market Committee is expected to cut interest rates by a quarter point, its third cut since July. The Fed will also release a statement, which it may tweak to indicate the door remains open to further rate cuts but that it could also pause in the process.
The Fed chairman then speaks at 2:30 p.m. ET, a half hour after the statement is released. Many bond pros expect a “hawkish” message, meaning the Fed will indicate it is holding off on rate cuts as it watches to see if there is progress in the economy or in the outside events that could impact the economy, like the trade war or Brexit.
“I think, in his mind, he had had two or three insurance cuts. This is the third, and then he sits back and waits,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.
“The question today is whether Powell is up to the task of portraying a neutral Fed when they really do not want to ease again in the near future,” notes Andrew Brenner of National Alliance.
Whatever the Fed does, it is likely to be criticized by President Donald Trump who has berated Powell and the Federal Reserve board, arguing its policy should be a lot easier.
Ahead of the meeting, the S&P 500 was trading at a new high, after recovering its prior high Monday. The S&P 500 was flattish Wednesday.
Treasury yields were also higher this week, signalling expectations for a hawkish Fed, meaning it plans no further rate cuts. Yields edged up Wednesday morning, following the report of third quarter growth of 1.9%, better than the 1.6% that was expected.
“It’s a really tough position…In June, they removed the word ‘patient’ and they cut at the next meeting. What they don’t want to do is set up something where they’re pre-committing to not cut if it’s needed,” said Jon Hill, rate strategist at BMO. “The Fed wants to be patient but act as appropriate, as necessary. It’s a combination of the two. They’re not saying they’re on hold, but they aren’t trying to guide the market into not expecting a December cut if the data doesn’t hold up. It’s definitely a communications challenge.”
Regardless of how the Fed words its statement, Powell’s job is made all the more difficult by the fact that there is such a wide divergence of views on Wall Street. There are Fed watchers who expect no more rate cuts this year or next, as well as those who see a recession coming and think the Fed will ultimately return to zero interest rates.
Goldman Sachs economists, for instance, expect the Fed to remove language from its statement that it will “act as appropriate” to sustain the economic recovery and also tweak the statement to indicate that Wednesday’s rate cut completes the Fed’s “midcycle adjustment.”
Yet, the fed funds futures market is pricing in about a 30% chance of a cut in December and more cutting next year..
“From our point of view, you’re likely to get a sell-off based on a Fed disappointment,” said Julian Emanuel, chief equity and derivatives strategist at BTIG.
Emanuel said he expects the Fed to cut a quarter point, but then back off promising any more cuts, though it may keep the door open just slightly. “We think the market has discounted a lot of positive news, and it’s likely to be shocked by this now,” he said.
Chance of no cut?
The issue for market pros is whether they believe the economy is weakening or not going into next year, and they are positioning for both outcomes.
Diane Swonk chief economist at Grant Thornton, said there’s a chance the Fed would not cut interest rates on Wednesday. Her theory is the Fed could cut in December, and if there is no trade deal or roll back of tariffs, it would have to cut even more next year to fight recession.
“I think there’s a better time to cut that’s more strategic. My rationale is when the market is already flirting with record highs…there might be a better time. They should hold their firepower,” said Swonk.
Stephen Stanley, Amherst Pierpont economist, said Fed officials have almost sounded like they’re not going to cut rates, but he expects there will be a cut Wednesday.
“It was a very interesting period between meetings…The vibe I was getting was they really weren’t all that excited about easing again. The committee was already divided. Some of the folks who had been in favor of easing through the first two moves were signalling they wanted to stop. [Dallas Fed President Rob] Kaplan in particular,” he said.
Stanley said the Fed may be reluctant to hold off on the cut because they view the situation as fragile. “The market’s bullied them and pushed them to be a lot easier than a lot of folks on the committee would have gotten to on their own,” he said. “At some point, the Fed is going to have to put its foot down.”
The Fed needs to improve its communications and be clear that it is taking a pause, Stanley said. “I think the risk is that the Fed underestimates the degree of clarity they need to provide to the markets to communicate effectively,” he said.
But there are those that do not expect a pause at all.
John Briggs, head of strategy at NatWest Markets, said he expects a cut Wednesday, one in December, another in the first quarter and one in the second quarter.
“Market consensus is for a “hawkish cut” where they cut but do not indicate any preference for more. That doesn’t mean they rule out more, but they go full data dependent,” Briggs said in a note. “I think they cut and try not to say anything, indicate openness and data dependency. I think indicating pause is risky.”