NEW YORK (S&P Global Ratings) Sept. 19, 2019--The Federal Open Market Committee (FOMC) has met some of the market's demands by cutting 25 basis points (bps) from its policy rate, bringing rates down to 1.75%-2.00% on Sept. 18--the second rate cut since 2008.
The policy action was in response to perceived economic downside risks tied to heightened trade tensions and global growth uncertainties, something that Fed Chairman Jerome Powell indicated as a possibility during his July press conference. While the move was in line with markets, the language accompanying the statement, together with economic projections from individual participants, calls into question whether the rate-cutting party will continue.
In contrast to the Fed dot plot median fed funds forecast, which signals no more rate cuts this year and next, S&P Global Economics now expects one more in December, the third cut for the year, depending on how the economic data evolves. This is contingent upon an escalation in trade tensions, further weakness in global growth, and increased geopolitical tensions. The Fed is then expected to remain on hold in 2020.
We will be watching whether the U.S. imposes additional protectionist measures, both tariff and non-tariff, on China, and vice versa. We will also be watching how the automobile trade dispute with the EU unfolds as key deadlines are crossed.
If the U.S. rolls back tariffs against China and the dispute with the EU dissipates, the Fed would likely remain on the sidelines in December. The Fed will also consider increased geopolitical risks, including further disruptions to oil supplies in the Middle East, when it decides whether another "insurance" cut is necessary.
At the same time, signs that prices have begun to warm will likely complicate the Fed's mission. Core CPI (Consumer Price Index) picked up once again in August, up 0.3% month over month and up 2.4% year over year, the third consecutive monthly acceleration in core CPI. The core personal consumption expenditures (PCE) deflator, arguably the Fed's preferred inflation indicator, has remained well below its 2.0% target. Historically, core CPI runs about 25 bps to 30 bps hotter than the core PCE deflator, suggesting an above-trend 2.1% reading for core PCE. Currently, core PCE has held at 1.6% year over year. If history is any measure of what to expect, the strength of core CPI suggests that we may see core PCE start to pick up soon.
The Fed action on Sept. 18, at the end of its two-day policy meeting, was a compromise in a divided group. Given three members voted against the move, it sounds like small steps are all the FOMC can muster. Two members voted against the September cut, as they did in July, preferring to raise the target rate to 2.0%-2.25%. Now, one more FOMC participant has jumped into the ring, St. Louis Fed President James Bullard, voting against the move, preferred a 50-basis-point cut instead.
It seems that the FOMC's September meeting only highlighted a growing difference of opinions among participants. The median FOMC member forecasts (the dot plots) indicating no more rate cuts will be appropriate by year-end (and remaining on hold the following year) hides the division among members. Only five members would like to stand pat after today's move, while another five participants see one rate hike by year-end as appropriate. The remaining seven Fed members believe another rate cut by year-end is appropriate. Next year, the dispersion widens further, with only two FOMC members remaining at the current 1.75%-2.00% range, eight indicating that a rate cut is merited, and seven wanting to tighten monetary policy.
While not every dot has voting status, the wide variation of individual expectations indicates that Chairman Powell will likely struggle to reach consensus among the members.
The views expressed here are the independent opinions of S&P Global's economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.
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