Fed still thinks ‘Current monetary policy stance is appropriate’
As expected, the Fed did not change its Fed funds target rate (still 1.50-1.75%) after three cuts in a row. The FOMC members thinking that the ‘current stance of monetary policy is appropriate’ have now been included in the statement officially, which, however, still highlights the challenges with slower global growth, a trade war and muted inflation pressure. Looking at the ‘dots’, 13 out of 17 FOMC members expect the target range to remain unchanged throughout 2020, while four expect one hike. It is striking that no one signals a cut, which is at odds with market pricing, as investors still price in a full cut next year. In general, the ‘dots’ over the coming years have a hawkish bias, as it is general trending up, despite Fed chair Powell basically ruled out hiking rates as long as inflation remains below 2%.
Our base case remains that the Fed will deliver a fourth cut some time during the spring, which is, however, not a high conviction call. Here we probably diverge from consensus amongst Fed watchers and are more aligned with market pricing (a full cut is priced in next year). We are not expecting the US to head for a recession, but we think the economy is a bit more fragile than the Fed does. While the US-China trade negotiations seem to be heading in the right direction, a phase 1 deal is in our view not enough to kick-start an investment boom, as the fundamental uncertainty in the short-run remains high, with negotiations probably moving to phase 2 (the permanent part), see also the US section in The Big Picture – Rays of light for the world economy, 2 December 2019. Many investment indicators are not looking too strong at the moment, in our opinion.
Market still going for another rate cut next year
We were right that the statement and dot plot would be on the hawkish side. However, Powell struck the market as more dovish, which in the end drove the market reaction, which was to send rates lower (2Y swap rates dropped around 3bp) and EUR/USD higher up to around 1.1140. We still see potential for a near-term Fed-led drop in EUR/USD, but clearly the market needs more convincing to add further to speculative short positions in EUR/USD. The rates market is priced for about a 25bp cut in December next year. The press conference did include some interesting details concerning liquidity issues in the USD money market. For example, Powell expressed satisfaction with the effect of the Fed’s liquidity provision through repos and T-bill purchases. He also let the market know the Fed is looking at possibly changing regulatory rules, which may help improve the functioning of the money market. Finally, he stressed that the issue of a standing repo facility will not be resolved before next year.
