The Artful Dodger Returns

The Federal Open Market Committee (FOMC) voted to cut rates one quarter-point in September, by an even more narrow margin than in July. Three voting members of the committee dissented. Two regional presidents, Esther George and Eric Rosengren of the Kansas City and Boston Feds, respectively, voted against another quarter-point cut in rates today. President James Bullard of the St. Louis Fed voted in favor of a larger, half-point cut in rates. The last time we saw three dissenting votes occurred in September 2016 when George, Rosengren and Loretta Mester of Cleveland all voted for a one quarter-point rate hike.

The last time we saw such dissonance in the views within the FOMC was in June 2013. Back then, George wanted to raise rates, while Bullard wanted the Fed to more aggressively to signal support for higher inflation. Inflation has run below the Fed’s 2% target since the target was chosen in 2012. The Fed’s defense of that target has varied. Most within the Fed are now confident that they have eased enough to get inflation back above the target.

Bullard is an outlier. Bullard had argued for a one half-percentage point cut at the July meeting, but did not dissent then even though he was not alone. President Neel Kashkari of the Minneapolis Fed has also consistently argued for a one half-percentage point cut. Bullard’s decision to dissent at this meeting and not July was unusual. He and Kaskari are clearly fighting an uphill battle on rate cuts and have decided to underscore their views with a dissent. Fed presidents take dissenting votes seriously; they do not like to go against their colleagues unless they feel strongly about their position.

According to the “dot plot,” five participants at the meeting this month were not pleased with two rate cuts this year. Another five feel they are done with rate cuts. Those ten FOMC members have indicated they are content to leave rates unchanged as we move into the latter part of the year and early 2020. The remaining seven want to see another rate cut this year, but not every dot indicates voting status.

Our forecast now includes one more rate cut in December, contingent upon shifts in trade policy. So far, tariffs have been more of a goal than a tactic. The next rate cut will also be contingent upon trade tensions and whether additional tariffs on China and Europe are imposed. If tariffs are rolled back, the Fed would likely remain on the sidelines in December. Other factors that could prompt the Fed to act include Brexit, financial instability abroad (largely China), major disruptions to oil supplies in the Middle East and geopolitical tensions more generally.

Fed Chairman Jay Powell held his cards close to his chest and would not commit to additional shifts in policy. Powell dodged all questions regarding the course of rates going forward and where he sits on the spectrum of views on display within the FOMC. He underscored that the bulk of the committee is now moving on a meeting-by-meeting basis. The exceptions are the two regional presidents who still wanted a half-point cut after the Fed had already cut by a quarter-point in July.

Chairman Powell was less open to using negative rates than he was a year ago, when he first argued that the Fed would consider negative rates. This should alleviate some concerns in the banking industry that negative rates might be on the horizon. It does not mean, however, the Fed has ruled out negative rates. Again, Powell dodged all questions that might lock the Fed into any future actions.

The Fed did not commit to permanent changes in the New York trading operations, which came under unusual stress this week. The fed funds rate spiked overnight on Monday and Tuesday, which prompted the Fed to provide more funds for trading. Powell announced some technical changes to deal with such stresses. He also said he would consider organic growth in the balance sheet sooner if needed.

Powell explained that he was not overly concerned about the recent inversion of the yield curve. He argued that negative rates abroad could be triggering some of that inversion. That said, he acknowledged that many within the Fed are watching the yield curve carefully to make sure they do not miss risks as they materialize. He is also concerned that weakness abroad will wash up on our own shores.

Bottom Line
Powell made it clear that the Fed is moving on a meeting-by-meeting basis. The “dot plot,” which suggests that 10 of 17 participants are done cutting this year should be taken with a grain of salt. Our forecast holds for a December rate cut, based on persistent weakness in investment. Another cut is possible if we see a hard Brexit before year-end.

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