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Fed Holds Cards Close

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The Federal Open Market Committee (FOMC) voted to cut rates by 0.25% to a range of 2 to 2.25% and decided to end the Fed’s balance sheet runoff two months early. Two regional Federal Reserve Bank presidents, Esther George of Kansas City and Eric Rosengren of Boston, voted against the rate cut. The dissents are important because they underscore the Fed’s independence from the White House and illustrate the tightrope it is walking between attempting to add a little heat to the expansion without further stoking asset price bubbles.

Weakness abroad, risks of further escalation in trade wars and tepid inflation were the reasons Chairman Jay Powell repeatedly listed for the rate cut. The Personal Consumption Expenditures (PCE) deflator, the Fed’s favored measure of inflation, has run below the explicit target of 2% since the Fed started targeting inflation in 2012. The last time we actually saw the core PCE (ex food and energy) deflator above the 2% threshold was in early 2012.

The statement left the door open to another cut in short-term rates later this year, but Chairman Powell would not commit to additional rate cuts. In fact, Powell repeatedly dodged questions about the threshold for another cut in rates. He remains the artful dodger.

Much will depend on how inflation and global growth perform. Another important issue is the divergence we are seeing between rates in the U.S. and abroad. This is triggering another level of financial instability because it has strengthened the dollar and caused an excessive depreciation in some developing economies. The Federal Reserve is attempting to close that gap; Powell said as much by citing expectations for rate cuts abroad.

He also underscored the uncertainty that businesses are citing over trade policy and the toll that is taking on investment. He argued that the benefits of a rate cut are more in terms of shoring up confidence than stimulating growth. Indeed, the benefits associated with this cut have already been felt. The turnaround in Fed policy triggered lower mortgage rates, a surge in mortgage refinancing and easier financial conditions for businesses.

Powell described the cut today as a “mid-cycle adjustment to policy,” which is about as vague as it can be. He said the forecast remains solid but faces significant risks. FOMC members will have to see how those risks evolve. He referred to this cut as “risk management.”

Bottom Line
The FOMC delivered more than expected by stopping the reductions in its balance sheet two months early. They provided much less than markets expected when it comes to additional rate cuts. This can be seen as a hawkish cut in rates.

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