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Fed losing some patience

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      By Andrew Szczurowski, CFA, Portfolio Manager, Global Income Group, Eaton Vance Management

      Boston — Patience may be a virtue, but it is no longer one that every member of the FOMC is comfortable with, as they removed it from their Fed statement. The Fed concluded their two-day meeting yesterday and while they kept interest rates on hold, half of the committee made significant downward revisions to their Fed Funds rate forecast (Dot Plot) for 2019.

      Looking at the details of the dot plot, seven of the 17 FOMC members now expect two cuts by the end of 2019, one expects one cut, eight believe there will be no change in policy rates and there is still one lone holdout for a hike this year. This is a pretty dramatic revision from last quarter, where 11 FOMC members expected no change in rates, four expected one hike, and two expected two hikes.

      Going into the Fed meeting, I thought the Fed was going to have a hard time meeting the market's lofty dovish expectations, but Chairman Powell was able to toe the dovish line perfectly, without actually wasting a rate-cut bullet at the meeting. The reason I thought it would be difficult to please the bond market and risk assets was the bond market was pricing in nearly three rate cuts coming into the meeting, so I didn't think they would be alright with a forecast that had half the committee at two cuts by year end. However, the downward dot plot revision and Powell's dovish press conference was enough for markets for the time being. Powell and the Fed statement mentioned that uncertainties to their outlook for the U.S. economy had increased recently, basically implying that the trade war had created downside risks to the economy that didn't exist at their last meeting.

      The Fed is in a very challenging position, the biggest uncertainty to their outlook is the trade war and unfortunately monetary policy is not a panacea for trade uncertainty. One could actually argue that cutting rates could empower the administration and prolong the trade war with China, which is the biggest issue at the moment holding back business confidence. With the stock market at an all-time high and unemployment at a 50-year low and trending lower, it seems like an odd time to begin a new cutting cycle, which could create new financial imbalances, but those are topics for another blog.

      Bottom line: The Fed has opened the door to a July rate cut, but the market sees it as a done deal. As of now, the market is pricing in roughly 1.5 cuts at the July Fed meeting. A cut in July may very well occur, but I believe the market's probability of a cut is too extreme given the biggest uncertainty in the U.S. economy right now is the trade war with China, which could be resolved in a few weeks, months, years or decades. All in all, I think a simple Excel "If" statement best describes the potential outcome from the Fed in July.

      =IF(Trump-Xi)G20 Talks(-)then(FF July)=2.0%

      But

      =IF(Trump-Xi)G20 Talks(+)then(FF July)=2.5%

      (Translation: Fed is likely to keep rates on hold if the G20 talks between Xi and Trump go well, but cut in July if they don't)