Fed announced to lower the policy rate by -25 bps to 2-2.25% in July. US dollar jumped while Wall Street declined although the decision came in widely anticipated. The market was probably disappointed by the lack of commitment of future rate cuts. The members remained confident about the domestic economic outlook, while they acknowledged higher risk of global slowdown and trade war uncertainty. The Fed also announced to end the balance sheet reduction plan, two months ahead of schedule.

Chair Jerome Powell indicated two key reasons for the rate cut. First, it is an insurance cut to avoid downside risks from global slowdown and trade war uncertainty to drag US growth. Indeed, Powell remained confident about the domestic outlook, noting that “there really is nothing in the US economy that presents a prominent near-term threat to the US economy”. Second, the rate cut aims at boosting inflation. According to Powell, “domestic inflation shortfall has continued” and that “global disinflationary pressures persist”. The decision was, however, not made unanimously as Kansas City Fed’s Esther George and Boston Fed’s Eric Rosengren dissented. Both preferred to maintain the policy rate unchanged.

On balance sheet reduction, Fed announced to end it in August, two months earlier than scheduled. In March, Fed noted that it would be completed by end-September. Going forward, mortgage-backed securities (MBS) principal payments up to US$20B per month will be reinvested in Treasuries matching the maturity composition of outstanding Treasury securities, while principal payments in excess of US$20B will be reinvested in MBS. Proceeds received from Treasuries would be reinvested in Treasuries. Powell noted that the decision was due to “consistency and simplicity”. We believe that the Fed attempted to avoid confusion in its monetary stance – cutting rates is easing measure while balance sheet reduction contains a tightening bias.

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Without signaling that another rate cut is coming soon, the forward guidance suggested that “as the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective”.

At the press conference, Powell characterized the rate cut as a “mid-cycle adjustment” to “adjust policy to a somewhat more accommodative stance over time”. This appears less dovish than some market participants’ expectations that the Fed has entered a rate easing cycle to combat recessionary risk. The discrepancy is likely the cause of the selloff in stock markets and rebound in greenback after the announcement.

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