Chair Powell remains clear on downside risks and the need to be pro-active. The FOMC will follow his lead.
The minutes from the September FOMC meeting again conveyed optimism over the economic outlook.
The FOMC’s positive view rests on the continued strength of the US labour market and hence consumer spending. Quantitatively this is seen in the unemployment rate being forecast to remain near its current level of 3.5% over the forecast horizon, and in GDP growth holding at or above trend over the period. These outturns are also expected to (finally) see a return to sustainable 2.0%yr PCE inflation in the medium term.
The above notwithstanding, at the September meeting, the FOMC still decided to cut the federal funds rate by 25bps. And in all of their joint communications since (including these minutes), they have noted greater concern over downside risks for the global economy as well as their effect on the US economy.
At the time of the September meeting, “Participants generally judged that downside risks to the outlook for economic activity had increased somewhat since their July meeting, particularly those stemming from trade policy uncertainty and conditions abroad”. Further, “a clearer picture of protracted weakness in investment spending, manufacturing production, and exports had emerged”.
Looking ahead, Committee members also highlighted that, “although readings on the labor market… continued to be strong”, “One [key] risk that the economy faced was that the softness recorded of late in firms’ capital formation, manufacturing, and exporting activities might spread to their hiring decisions, with adverse implications for household income and spending”.
While only perceived as a risk by the Committee at September, this is a view that has been embedded into our own forecasts since the last escalation of trade tensions with China back in August, when we revised our forecast for two rate cuts to four by year end. Thereafter in September, we added a further two cuts to this profile in 2020, with a terminal rate of 0.875% seen at June 2020.
Notably, a day ahead of the release of these minutes, Chair Powell took considerable time in a key speech to highlight that the starting point for the US labour market is weaker than previously thought.
Speaking at the Annual Meeting of the National Association for Business Economics in Denver, Chair Powell outlined that recent BLS preliminary guidance on revisions to nonfarm payrolls for the year to March 2019 points to the month-average pace for the period falling from 210k currently to 170k once formally incorporated into the data in February 2020.
Chair Powell went on to note that “experience with past revisions suggests that some part of the benchmark will likely carry forward”. Hence the 157k average of the past 3 months is also likely an overestimate of current employment growth, to which leading indicators of employment such as the ISMs point to further downside risk. Given the information in these revisions and the leading indicators, it is less surprising that hourly earnings growth decelerated to a sub-3%yr pace in September even as the unemployment rate printed at 3.5%, a 50-year low.
Very clearly then, with respect to the labour market and the consequences for activity growth and inflation, there is strong cause to cut rates further to sustain this growth in this cycle near trend. To do so, we continue to believe a further 100bps of cuts will prove necessary.
With the Committee acting meeting-by-meeting, the timing of delivery remains susceptible to the data flow. However, for Chair Powell and, to a lesser extent, the Committee majority, prudent risk management and concern over proximity to the effective lower bound (ELB) respectively point to a near-term continuation of cuts.
During his September press conference, Chair Powell emphasised that “history teaches us it’s better to be pro-active in adjusting policy”. And in Q&A after the NABE speech, Chair Powell went on to highlight that: the ”data don’t reveal elevated risks to cutting interest rates right now”; extending the current strong labour market is a “very high priority”; and, presumably with respect to confidence, “an inverted yield curve would be uncomfortable to maintain for an extended period”
From the Committee more broadly on the ELB, the minutes noted: “Participants generally agreed with the staff’s analysis that the risk of future ELB episodes had likely increased over time, and that future ELB episodes and the reduced effect of resource utilization on inflation could inhibit the Committee’s ability to achieve its employment and inflation objectives”, potentially making “makeup” strategies necessary to achieve the Committee’s longer-run objectives – discussed at length in September.
Given the above and the continued deterioration of current conditions, it seems most appropriate to us to expect the FOMC to deliver in October and December and, if we are right about the continued deterioration of the economy into 2020, to expect two further cuts in the first half of 2020, most likely March and June.
