Threshold to cut is enduring uncertainty, not a further deterioration in conditions.
The minutes of the June FOMC meeting and Chair Powell’s Semiannual Monetary Policy Report to Congress provided support for the view that the July FOMC meeting will see a federal funds rate cut, and that further easing will follow in due course.
From the June meeting minutes, “Although nearly all members agreed to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent at this meeting, they generally agreed that risks and uncertainties surrounding the economic outlook had intensified and many judged that additional policy accommodation would be warranted if they continued to weigh on the economic outlook”.
From “if they continued to weigh”, it is clear that a further deterioration in conditions is not necessary to justify a cut. Instead, the threshold is simply that current uncertainties persist.
From Chair Powell’s appearance before Congress, this seems a near certainty ahead of the July meeting, with the global cross-currents seen as numerous and largely open-ended in nature.
In Chair Powell’s view, “uncertainties about the outlook have [actually] increased in recent months. In particular, economic momentum appears to have slowed in some major foreign economies… [and] a number of government policy issues have yet to be resolved, including trade developments, the federal debt ceiling, and Brexit”.
To be clear, policy easing is not warranted merely because these uncertainties exist, but rather as there is clear evidence they are affecting the US economy, particularly business investment.
From the June minutes, behind the revision of the appropriate path of the federal funds rate by “nearly all” Committee members (i.e. the pricing in of two cuts by end-2019) were “recent weak indicators for business confidence, business spending and manufacturing activity”. Private sector analysts were also noted to have “marked down their forecasts for longer-term corporate profit growth”. And “contacts reported that softer export sales, weaker economic activity abroad, and elevated levels of uncertainty regarding the global outlook were weighing on business sentiment and leading firms to reassess plans for investment spending”.
Emphasising that this is not just a matter for the July decision, “Several participants noted comments from business contacts reporting that their base case now assumed that uncertainties about the global outlook would remain prominent over the medium term and would continue to act as a drag on investment. Several participants also noted reports from some business contacts in the manufacturing sector suggesting that they were putting capital expenditures or hiring plans on hold and were reevaluating their global supply chains in light of trade uncertainties.”
It seems most appropriate then to not only anticipate a cut in July, but also a follow-up move later in the year – as we have anticipated for some time, and to which the FOMC’s June forecasts also correspond. This view is also supported by the aforementioned potential for fiscal uncertainty in the December quarter, specifically the “possibility that federal budget negotiations could result in a sharp reduction in government spending or that negotiations to raise the federal debt limit could be prolonged”.
In terms of the timing of a second cut, October seems most likely given the focus on risk management and sentiment in these communications. However, the call between October and December will remain finely balanced until we see a few more months of data, and progress in resolving trade and fiscal uncertainties can be gauged.
Regarding the likelihood of the Committee going further than the two cuts the FOMC and Westpac are forecasting, the state of the consumer will prove critical.
As above, up until now, the impact of global uncertainties has been restricted to the business sector, particularly their investment decisions. However, as made clear by the recent loss of momentum in hourly and weekly earnings growth (despite the unemployment rate being at multi-decade lows), there is a clear risk that employment and wage growth will also be hit.
If this occurs, then the cornerstone of the FOMC’s positive baseline view for GDP growth and inflation will be threatened, begetting a need to cut further.
To our mind, the probability of such an outcome is currently well below 50%, but not immaterial. Employment, wages and consumer sentiment will therefore remain key in coming months.