Probability of a rate cut rises, but it’s unlikely to be in July

What we heard from the U.S. Federal Reserve on Wednesday is consistent with our base case expectation of two interest-rate cuts in the next 12 months, beginning in September. 

Yesterday’s communication from the U.S. Federal Reserve (Fed) strengthened our belief that the central bank is primarily concerned that ongoing uncertainty is damaging confidence and, by extension, business investment. We believe the Fed is hoping to compile a dossier pointing to economic weakness that will enable it to cut interest rates credibly, but we don’t think enough weak data points will emerge in time to justify a cut in July.

• We remain upbeat about global equities: Proactive rate cuts (i.e., early) have historically benefited the equities space more as opposed to reactive (i.e., late) rate cuts. At this point, we’re still in the “proactive” end of the spectrum.
• We continue to believe that the U.S. dollar (USD) will remain rangebound, with upside potential. While the Fed has made a dovish pivot, it’s largely priced into the U.S. market¹ and we see substantial scope for global central banks, particularly the European Central Bank and the People’s Bank of China, to engage in more aggressive easing activity in the next month—developments that could offset USD weakness.
• We believe the Fed will have trouble delivering more rate cuts than what has already been priced into the fixed-income market. However, if data deteriorates in the coming weeks, there could be scope for the Fed to act sooner and take bolder actions. 

1. Fed Chair Jerome Powell repeatedly noted that the outlook for the U.S. economy remains sound, highlighting that wages are rising, jobs are plentiful, and consumer confidence is high.² The Fed’s concerns are related to what he refers to as two specific crosscurrents: trade tensions and global growth. We think these are one and the same—the deterioration in global trade activity has been exacerbated by trade tensions and their affiliated uncertainty.
   
   Interestingly, when he was asked whether a U.S.-China trade deal would erase his concerns, the Fed chair highlighted that he cared more about the economy’s response to it. We take that to mean that the central bank is far more focused on whether economic activity is deteriorating because of policy uncertainty than the content of the trade policies. That implies the Fed will be hyper data dependent in the coming months, even if the phrase “data dependent” seems to have exited its more recent communication. We should be prepared for substantial volatility around key economic releases over the next several months.
   
   
2. At the press conference, Chair Powell made several references to the Fed’s need to “see more” to get a sense of how risks are weighing on the U.S. economic outlook—are they a blip in the road or a sign of more sustained weakness? Critically, he referenced the weak May jobs report (only 75,000 jobs were added during the month) and noted that the Fed typically requires three to six months’ worth of data to get a sense of the overall trend.
   
   When asked if the Fed felt there were risks associated with cutting rates too early, Chair Powell suggested they didn’t feel the case for cuts was urgent. He also noted that there hadn’t been any support—save for one individual—for cutting rates at the June meeting. In our view, barring major developments, it’s difficult to see how the majority of the Fed’s voting members would swing from wanting to keep rates on hold in June to supporting a rate cut in the space of six weeks.
   
   
3. The Fed’s economic projections—little has changed. We were surprised by how little the Fed’s economic projections³ had changed. Indeed, GDP and unemployment were revised higher over the forecast period, long-run estimates of growth and unemployment were unchanged, and only core inflation was revised downward (mildly). If all we had received from the Fed on Wednesday were its projections, I would have believed this central bank was neutral to hawkish. 

Chair Powell’s dovish tone, along with the Fed’s little-changed economic forecast, creates a challenge for economists and markets: What is the Fed’s true decision-making function? Is it in flux? The inconsistency, in my view, may create more volatility in the market and could risk longer-term credibility issues for the Fed. For now, however, Chair Powell can get away with claiming that the central bank’s views are consistent with its base case expectation of a healthy U.S. economy, albeit one that faces significant downside risks. 

1 Bloomberg, as of June 19, 2019. 2 FOMC Press Conference, June 19, 2019. 3 Projections, U.S. Federal Reserve, June 19, 2019.