ECONOMIC UPDATE

  • The Fed met market expectations with a July rate cut, but future policy is less certain.
  • The U.S. and China resumed negotiations during the last week of July and the Trump administration has discussed potential waivers for American tech firms selling products to Huawei.
  • President Trump roiled markets on August 1 tweeting that new tariffs would be levied against China in September.

The month of July concluded with a widely expected rate cut from the Federal Reserve, lowering the fed funds target range 25 basis points (bps) to 2% – 2.25%. The interest on excess reserves (IOER) rate was also lowered by 25 bps to 2.10% and the Fed will end balance-sheet reduction two months ahead of what was previously scheduled (also expected ahead of the meeting). Fed funds futures had been pricing for rate cuts since late 2018, and the probability of a July cut rose to 100% following Fed Chair Jerome Powell’s testimony before Congress on July 10. As such, market participants were more focused on the FOMC’s tone and forward guidance following its July 31 meeting. Would the Fed characterize the move as the beginning of a new easing cycle, or would the July decision be more of a one-and-done “insurance” cut? The official statement and press conference were not totally clear (or perhaps inconsistent) on that front.

The official statement was digested by the markets first and there were no key words included that would suggest the rate cut was an isolated event. It pointed to global uncertainty (largely trade concerns) and muted inflation pressures, which were highlighted in previous FOMC statements. Powell’s press conference was less clear with regards to future policy decisions. He initially characterized the rate decision as a “mid-cycle adjustment to policy.” When pressed for clarification by a Reuters reporter, Powell said it shouldn’t be considered “the beginning of a lengthy cutting cycle.” Powell later explained further:

“Let me be clear. 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. I said when you think about rate cutting cycles they go on for a long time. The Committee is not seeing that, not seeing us in that place. You would do that if you saw real economic weakness and thought the federal funds needed to be cut a lot. That’s not what we’re seeing.”

This decision would appear to be representative of a Fed that was hesitant to disappoint the markets. Powell continues to highlight positive economic conditions, such as full employment, trend GDP, and near-record stock valuations. Some would argue that these are largely lagging indicators, but the Fed has been under much pressure from the markets (and the White House) to act amid global disinflation pressures (and below-target inflation domestically). Powell appears to be hopeful that a “mid-cycle adjustment” will be sufficient and, as he noted in his post-meeting comments, such a move is not unprecedented. Some would argue that a resumption of quantitative easing would be a more effective response to disinflation pressures than a rate cut, but that is a whole other discussion. The markets are simply more skeptical with regards to the global and domestic economic outlook, and the immediate reaction in financial markets reflected a less-dovish assessment of future Fed policy. Implied rates on fed funds futures rose (now effectively pricing for one more cut in 2019), and stock prices fell nearly 1%. The Treasury curve bull flattened, with short-term yields slightly higher and long-term yields lower.

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