Stop, collaborate and listen.... Fed presses pause button on future rate cuts

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      By Andrew Szczurowski, CFAPortfolio Manager, Global Income Group, Eaton Vance Management and Eric Stein, CFACo-Director of Global Income, Eaton Vance Management

      Boston - As expected, the Federal Open Market Committee (FOMC) lowered the fed funds rate 25 basis points (bps) to a target range of 1.50% to 1.75% at yesterday's meeting — the third such cut in the "mid-cycle adjustment" this year. U.S. Federal Reserve (Fed) policymakers seem content for the time being to keep further rate cuts on hold.

      Fed Chair Powell said at the press conference that "monetary policy is in a good place" and that "the current stance of monetary policy is likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook."

      Translation? Barring a deterioration in economic data, the Fed doesn't see a need to cut rates anytime soon. Monetary policy works on a lag, so the Fed wants to put rate cuts on pause to see how much stimulus those rate cuts will have.

      Fed chair acting as the economy's coach

      Powell has two explicit goals in his mandate: stable prices and full employment. We argue here that financial stability is a third implicit mandate related to goals one and two. The Fed chair also has another job as the economy's coach, requiring him to exude confidence that monetary policymakers have the tools and the ability to land the economy safely in the neighborhood of potential growth.

      If Chair Powell comes to the podium and says things look really bad out there... well, that would likely become a self-fulfilling prophecy and the economic data would deteriorate. Conversely, if he asserts that the economy is so strong that the Fed needs to keep hiking, financial conditions — through lower risk asset prices and higher bond market yields — would pull the tightening forward and limit their ability to hike in the future. We saw that in November 2018 after Powell's "a long way from neutral" comment.

      In our view, for the Fed to get the most bang for the buck out of any rate cut, it would be better to follow up with dovish language that prevents financial markets from reversing the benefits of the policy change.

      Markets reacting as much to the pause as the rate cut

      Telling the markets on Wednesday that the Fed was going to pause would normally take away some of the rate cut's stimulus. And we saw that happen after the FOMC statement was released. During the early part of Powell's press conference, the U.S. dollar rallied, bond yields rose at the short end of the curve and risk assets sold off.

      Powell was able to walk markets back a bit as the press conference went on. When asked what would make him think it was appropriate to raise rates again, he answered that the Fed would need to see inflation move up significantly — although that's not in their forecast as inflation expectations have moved down or sideways. This was the carrot the markets seemed to be looking for, sending equities higher, the dollar lower and bond yields much lower.

      Dissenting votes and market expectations

      So the Fed may not be cutting anytime soon, nor are they likely to hike in the foreseeable future. There were two dissents among the FOMC members, as Eric Rosengren and Esther George again voted against the rate cut. We suspect Boston Fed President Rosengren has looked through his window a couple blocks from our offices and realized that with so many new skyscrapers going up in the Seaport, perhaps lower interest rates and easier financial conditions aren't necessary.

      As for what the market is pricing in, fed fund futures trading now suggests approximately one more cut to come by the end of 2020 — a big change from two months ago, when the market was pricing in three more cuts by then.

      Bottom line: Monetary policy is no longer on the preset course of the past few years, when it was biased first to hike and then to cut. If we see economic data stabilize or improve, the Fed's mid-cycle adjustment would end. Any escalation in the trade war that erodes business and consumer confidence, and the Fed would look to use a few of its seven remaining rate cut bullets. Without a bias in either direction, Fed policy decisions in the coming months may once again put labor and inflation data at the forefront.