Policy Easing Continues: Following the mid-cycle adjustment that took place in July and an insurance cut in September, the FOMC delivered its third consecutive monetary policy modification. With a vote to reduce the Fed Funds rate by another 25 bps, the targeted range now stands at 1.50% to 1.75%. As has been the case for recent meetings, this decision was well-anticipated by the market, with a >80% implied probability of further accommodation reflected in the futures market since early October. Although Federal Reserve officials had ample opportunity to redirect expectations, and there were again two more hawkish dissenters within the group, they chose not to do so as uncertainty persists on varied fronts both domestically and abroad.
Earlier in the month, Chair Powell had already announced plans to resume balance sheet expansion via purchases of $60 billion per month in T-Bills. This decision came in response to September’s notable volatility in the overnight repo lending market and will coincidently help to fund the country’s meaningful deficit. While unwilling to call these operations quantitative easing (QE), the impact thus far has been very similar to the past as equity market volatility (as measured by VIX) has begun to steadily drop.
Decoding the Message: The official statement indicated again that “economic activity has been rising at a moderate rate.” While subject to later revision, annualized GDP for 3Q-19 was reported at 1.9% just ahead of the Fed’s release. This exceeded the 1.6% consensus expectation with consumer spending up at a solid 2.9% rate even as private investment continued to detract.
Consistent with recent payroll reports, the statement again highlighted how “the labor market remains strong” and that “job gains have been solid, on average.” With 108 consecutive months of payroll expansion, the official unemployment rate was at a 50-year low of 3.5% in September. That said, moderate year-over-year wage growth has not yet induced inflationary pressures.
Accordingly, the statement noted how “market-based measures of inflation compensation remain low” and “survey-based measures of longer-term inflation expectations are little changed.” The Fed’s preferred measure (Core PCE) was at 1.8% in August and remains below the symmetric 2.0% target. Breakeven inflation rates remain well-contained, conveying the market’s view that it’s hard to get an acceleration in inflation when total spending is growing so moderately and so steadily.
Market Reaction: Importantly, the Committee dropped prior language suggesting it would “act as appropriate to sustain the expansion.” This first appeared in mid-June, just weeks before the inception of policy easing, and perhaps signals a more data dependent approach biased toward a pause rather than additional cuts. While Fed Funds futures reflect this view near-term, pricing no further action before year-end, expectations still call for at least one more cut over the next 12-months. Looking over the past month, the fixed income yield curve is notably steeper and major US equity benchmarks have established all-time highs. The statement and the press conference generally met the market’s expectations, as afternoon trading was relatively muted.
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