FOMC Oct'19 meeting Preview: Time to cut again

The Federal Reserve (Fed) decision is due later today and we expect the FOMC to cut its target rates by 25bps that would bring the rate to a range of 1.5% to 1.75% (currently at 1.75%-2%). This would be the third successive rate cut, making the policy slightly more accommodative.  Fed Fund futures markets are pricing in a 95% chance of another 25basis point cut. However, the interesting element of this future probability distribution is that markets are currently only pricing in another 25bps move until the Fed returns to their neutral stance.

Since the last meeting, growth data has been mixed but it is close to the Committee's baseline view, and thus there should be minor changes to their economic assessment. Weaker manufacturing data and increased risk to the outlook make the case for a 25 basis point “insurance” cut. From an employment perspective, we have seen sharp declines in both the ADP and headline payrolls numbers, hitting 135,000 and 136,000 consecutively and the ISM Manufacturing and Non-Manufacturing surveys both fell sharply last month. The ISM’s manufacturing index fell 1.3 points to 47.8 in September and ISM’s non-manufacturing index dropped to 52.6 in September, down from 56.4 in August, dropping to levels not seen since 2009 and 2012, respectively. Third quarter growth estimates from the Atlanta Fed’s GDP now were running at 1.9% the week of the September meeting. The current projection from October 28th is 1.7%.

The two recent cuts have been effective, as measured by the relationship between the three-month and ten-year U.S. Treasury bond yields. Yields are beginning to normalize, with short-term yields down more than long-term yields, and a return to a positively sloped yield curve — the ten-year yield now exceeds the three-month yield. This is a favorable development for those who believe an inverted yield curve signals a recession. We expect the curve to continue to steepen following the expected cut.

It will be interesting to hear the Feds message about the future direction of interest rates. The geopolitical issues such as Brexit and the trade war between the U.S. and China, the slowdown in global manufacturing activity and the slowdown in economic activity in Europe and other developed economies posed significant risks to U.S. economy. The tentative agreement between the US and China two weeks ago suspended the planned 5% tariff hike on USD250 billion of imports. In coming weeks, the US and China will continue to draft a written agreement on a limited “Phase One” agreement ahead of the APEC summit in mid-November. If the American and Chinese economies resume a stronger trajectory, the rest of the globe will follow. 

The biggest question for us is whether there'll be any other announcements or adjustments to the “don't-call-it-QE” program of asset purchases. If Powell indicates that the program could expand from here, or expresses pessimism about any other aspect of the economy, the US dollar could retrace last week's gains. Fed Chair Powell may adopt a slightly hawkish tone, by alluding to a baseline of unchanged policy while emphasizing data dependence and the ability to respond quickly if the outlook deteriorates. Recent Fed official comments continue to suggest diverse opinions about the appropriate policy stance, with many implying scope for additional cuts beyond October and others maintaining their hawkish dissents.


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