Powell Must Bring Together a Fragmented Fed

The Federal Open Market Committee (FOMC) is widely expected to cut rates again at the conclusion of its meeting next Wednesday. What market participants ignore is how difficult that decision will be for many participants at the meeting.

Four regional Fed presidents objected to the cut in rates in July, two who were in the position to dissent, and will do so again in September. The two who wanted a half-point cut in July could be a little more tempered this time. They will be countered with arguments that the recent acceleration in core CPI inflation suggests that the weakness in inflation we have seen is transitory instead of persistent as they once argued. That leaves the slim majority who voted for a cut in rates in July. They were most concerned about hedging the downside risks associated with the slowdown abroad and escalation in trade tensions. Concerns that inflation is too low have lessened. Growth in the broader economy is slowing, but the consumer is holding up well. The sustained strength of the consumer will be a point of emphasis for the Fed in the statement that follows the FOMC meeting.

Federal Reserve Chairman Jay Powell will lay out a tenuous consensus to cut rates but remain reluctant to commit to more rate cuts during the press conference that follows the meeting and the release of the official statement. The forecasts that the FOMC shares for 2020 along with the dot plot on prospective rate cuts will be lower than in June, but only modestly. It would be ideal for the committee to decide to delay the release of the dot plot (which seems to confuse more than clarify the committee’s views on rate cuts) until the release of the minutes for the meeting. The dots don’t mean what many think they do; that could further undermine Powell’s messaging, without the context of the committee’s debate provided by the minutes.

Powell was sideswiped by the spectrum of debate and views on rate cuts after the last meeting. He has proven himself to be a quick learner and will be much more practiced in his comments this time around. Look for him to emphasize the committee’s confidence in the performance of the economy thus far and efforts to hedge against downside risks. The key for Powell will be to underscore the ongoing strength of the economy and the desire by the committee to hold their ammunition, which is limited, until they see worse economic data on the economy and/or a significant tightening of credit conditions. They do not want to repeat the mistakes of last December when they looked asleep at the wheel as credit conditions tightened in financial markets.

The president will no doubt complain, but that has become par for the course. Holding back on rate cuts could actually play to the Fed’s advantage, as it underscores the independence of the Federal Reserve from political meddling.

The forecast for rare cuts is now highly contingent upon two factors: 1) The spillover effects of weakness abroad, and 2) the trajectory of trade tensions both at home and abroad. The first is expected to show up as weaker growth in the fourth quarter and prompt one more rate cut in December. The push to delay Brexit and a renewed desire to call a truce in the trade war with China, and even pullback on some tariffs, makes a fourth rate cut this year less likely.

That said, China is playing a long game and remains unwilling to really deal with the intellectual property infractions that have enraged their trading partners. And, while we are still only one tweet away from another escalation in the trade war with China, Europe remains in the cross hairs of the administration, which threatens German autos and French wine among other imports.

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