Divided Fed Exposed: Bullard Fears Recession, Rosengren Sees Bubbles & Too Much Leverage

Never has The Fed been more diametrically split than in the latest meeting, as highlighted by both the three dissents (2 hawkish and 1 dovish) as well as the three clear cohorts as indicated by the dot plot.

  1. Pre-emptive accommodation is not needed; we've already done too much

  2. We've delivered the necessary amount of pre-emptive accommodation for now

  3. More pre-emptive accommodation is needed

However, this morning we get clarity of the competing views as Boston Fed President Eric Rosengren and St.Louis Fed President Bullard (two of the three dissenters) lay out there reasons... and they could not be more different.

Jim Bullard - a well-known dove - dissented because he wanted a 50bps rate cut, fearing recessionary forces are growing. Here's what he sees:

I dissented with the Federal Open Market Committee (FOMC) decision announced on Sept. 18, 2019, to lower the target range for the federal funds rate by 25 basis points to 1.75%-2.00%. In my view, lowering the target range by 50 basis points to 1.50%-1.75% would have been a more appropriate action. The following considerations factored into my decision.

First, there are signs that U.S. economic growth is expected to slow in the near horizon. Trade policy uncertainty remains elevated, U.S. manufacturing already appears in recession, and many estimates of recession probabilities have risen from low to moderate levels. Moreover, the yield curve is inverted, and our policy rate remains above government bond yields for nearly every country in the G-7.

Second, core and headline personal consumption expenditures (PCE) inflation measures continue to run some 40 to 60 basis points, respectively, below the FOMC’s 2% inflation target. Market-based measures of inflation expectations continue to indicate expected longer-term inflation rates substantially below the Committee’s target. This is occurring despite the 25 basis point cut in July and the 25 basis point cut that was expected for the September meeting. While the unemployment rate is low by historical standards, there is little evidence that low unemployment poses a significant inflation risk in the current environment.

In light of these developments, I believe that lowering the target range for the federal funds rate by 50 basis points at this time would provide insurance against further declines in expected inflation and a slowing economy subject to elevated downside risks. It is prudent risk management, in my view, to cut the policy rate aggressively now and then later increase it should the downside risks not materialize. At the same time, a 50 basis point cut at this time would help promote a more rapid return of inflation and inflation expectations to target.

Although I disagreed with the Committee’s decision to lower its target range by only 25 basis points, I remain confident that the Committee will continue to monitor economic developments and respond accordingly as economic circumstances dictate. I look forward to working with my colleagues to fulfill the FOMC’s mandates.

Eric Rosengren, on the other hand, sees costs in what The Fed is doing and fears the consequences in asset prices:

The stance of monetary policy is accommodative. Additional monetary stimulus is not needed for an economy where labor markets are already tight, and risks further inflating the prices of risky assets  and encouraging households and firms to take on too much leverage. While risks clearly exist related  to trade and geopolitical concerns, lowering rates to address uncertainty is not costless.

The following four charts reflect the key data on which I base this view, with each chart’s title  summarizing a key point. Also, I will describe my views in more detail in a speech taking place today at 11:20 a.m., entitled Assessing Economic Conditions and Risks to Financial Stability.

(1) Labor markets are already tight

(2) Current monetary policy is accommodative

(3) The federal funds target rate is below the inflation target

(4) Low interest rates are encouraging more leverage in underwritten riskier debt transactions

So it is pretty clear who President Trump will prefer.