Submitted by Nicholas Colas of DataTrek Research
Markets want to hear something very specific from the FOMC and Chair Powell: that the Fed will cut rates today, again in September, and maybe once more at year-end, no excuses. Assuming the Fed wants to wrestle the policy-making wheel away from Mr. Market, Chair Powell will have to contextualize the novel reasons for these moves – inoculating the US economy from global weakness and spurring inflationary growth – at his press conference. His credibility is already low from his U-turn on rates in January; he has to get this one right.
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If we hear today is “the most important Fed meeting ever” one more time, we may just lose it. Yes, we’ll certainly see the first rate cut since 2007. Yes, global capital markets have bullied the Fed into this move; if German bunds had a positive yield no one would be expecting anything from Chair Powell and the FOMC. But anyone who sat in front of a screen during the Financial Crisis knows today’s rate decision doesn’t even crack the top 5 list for the most consequential Fed meeting of all time.
Rant over… so let’s talk about market expectations for future Fed policy through the lens of Fed Funds Futures:
- Odds overwhelmingly favor (78%) a 25 basis point cut.
- Odds of a 50 bp cut are just 22%, down from 32% a month ago.
September 18th meeting:
- With 7 weeks more economic data under our belt, markets expect the Fed will still be on an easing track.
- Assuming the all-but-certain cut today, Futures put the odds of another cut at the meeting at 55%.
- The odds the Fed will stand pat after today’s cut are just 33%.
- The dark horse possibility (12%) is that the Fed has cut by 50 bp at either today’s meeting or in September.
October 30th meeting:
- Futures pricing points to a pause here, even with the possible overhang of a Halloween Brexit (the current deadline).
- The odds that Fed Funds are 50 bp lower than today (i.e. cuts in July and September) are 47%, the most likely outcome according to Futures pricing.
- Odds that rates are 75 bp lower or just 25 bp lower are pretty even at 29% and 20% respectively.
December 2018 meeting:
Odds are split between Fed Funds that are 50 bp (37%) or 75 bp (35%) lower than today.
- April 2020 meeting:
- This is as far as the CME FedWatch Tool goes at present.
- Quoted odds are all over the map, ranging from Fed Funds at 50-75 bp (0.4%) all the way to 2.00% - 2.25% (5.6%).
- The most likely outcomes at present look to be 75 bp lower than today (32%), followed by 100 bp lower (26%) or just 50 bp lower (21%).
What all this means as we watch Chair Powell’s press conference today:
#1: Markets expect the Fed to communicate a policy of further rate cuts through the rest of 2019. That is the key takeaway from the Fed Funds Futures data. Any messaging that includes skipping the September meeting will cause investors to worry about a “one and done” strategy.
#2: Futures have largely taken a 50 bp cut at any 2019 meeting off the table, and the Fed would do well to echo that sentiment. NY Fed president Williams’ recent misstep on this count, where he publicly discussed the academic merits of a “go early, go big” rate cut and temporarily confused markets, should have been a teaching moment for policymakers.
#3: What investors really want from the Fed can be summarized in one word: “clarity”. That’s because…
- We are in an unusual place just now with decent US economic growth but markets still expecting the Fed to cut rates at least twice in 2019.
- The usual rate cut set-up – growing unemployment, weakening consumer confidence, and/or a geopolitical shock – does not apply.
- The issues that concern the Fed just now – sluggish inflation and slack non-US growth – are new vectors to explain a rate cut. Are Fed Funds that are 50 bp lower than today enough to insulate the US from the rest of the world’s problems? And will 75 bp really spark incremental inflation? The truth is no one knows.
Bottom line: while this is not “the most important Fed meeting ever”, it is certainly one that will set the tone for the rest of 2019. Chair Powell has already shaken markets once with his late 2018 chatter about higher neutral rates. How he will communicate the exact opposite perspective just 8 months later will either allow him to start managing market expectations or just leave him as a passenger on the bus.