Chairman Jerome Powell’s comments after the Fed’s expected rate cut are seen as confusing, and market pros say monetary policy has become muddled.
The bottom line is the Fed is still expected to cut interest rates again, but possibly not as much as markets had been geared up for.
The Fed sliced a quarter point off the fed funds target rate range Wednesday, citing “global developments” and “muted inflation.” The 2 p.m. ET statement was viewed as neutral by the market with no set promise of further interest rate cuts. The market had been braced for a very dovish message, expecting the Fed to leave the door wide open and leaning more explicitly toward further interest rate cuts, so it was already somewhat disappointed.
But once Powell spoke about a half hour later, the markets convulsed, with bond yields spiking and stocks selling off into the close. His comments that the Fed was making a “midcycle adjustment ” and was not in a longer-term rate cutting mode ricocheted through the markets, where some investors had been positioned for at least two more cuts this year alone. Powell did not rule out further rate cuts.
“We find Powell confusing. I think this is an ongoing struggle with this Fed and communications. The point is you now have to look at a September cut as more of a 50/50 probability,” said John Briggs, head of strategy at NatWest Markets.
Stocks plunged, with the Dow down 333 points in its worst day since May. Treasury yields were on a roller coaster with the 2-year yield, which most reflects Fed policy, spiking as high as 1.96%, off an early low of 1.79% prior to the Fed statement.
“It was a very confusing and muddled message, and I don’t think that Powell delivered clear direction for what the near-term path of additional Fed easing will be, and I think that’s why the market reacted negatively,” said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch.
The Fed had set itself up with the difficult task of explaining a so-called insurance cut. That’s a rate cut intended to head off economic weakness before it hits. The Fed’s problem, in part, is that it was making the cut, just as some economic data has been improving. So while acknowledging the improvement , it also was forced to emphasize that it’s real worries are sluggish inflation, potential trade war impacts and the weaker global economy.
Two Fed presidents, Boston Fed President Eric Rosengren and Kansas City Fed President Esther George, objected on the basis that a cut was not warranted, and that also confused markets about future policy.
“The market was looking for more cuts and the markets now are very uncertain. I don’t think that’s helpful for what the Fed wants to achieve. I think the Fed wants to extend the expansion,” Cabana said, adding that the Fed statement was much more clear than Powell. He now expects other Fed officials to attempt to clarify the Fed position.
For now, Cabana said he will stay focused on the Fed’s statement, which clearly said the Fed is concerned about the implications of global developments and muted inflationary pressure. “Neither of those things are going to change any time soon,” he said, noting Powell did not even mention the risks around Brexit, the U.K.’s exit from the European Union, by the end of October.
J.P. Morgan chief U.S. economist Michael Feroli said the Fed may keep its focus on trade and global issues, but its next decisions may actually be made based more on U.S. economic data. The Fed had also added a level of confusion into markets when it pivoted recently, from its normal “data dependence” on the U.S. economy to concerns of more global issues.
“Today’s Fed events may have given risk markets a little indigestion, but they also bought the Fed a little more flexibility going into the next FOMC meeting,” he wrote. “We still look for one more easing in September, and continue to believe that, unlike today’s meeting, the call on September depends on all of the data. While today’s move was motivated by global growth, trade policy and inflation developments, we expect September’s decision will also depend on domestic growth developments.”
The Fed statement also said the Fed was looking to sustain the economic expansion, which it has stated before. Powell repeated that in his opening remarks but he was also positive on the outlook when he said trade tensions had been boiling over but were now “simmering.”
“He delivered no consistent message. He talked from both sides of his mouth, and the market didn’t know what to make of it,” said Cabana.
How many cuts?
Cabana said the futures market had been pricing in 70 basis points of easing for the year, including the 25 basis point cut Wednesday. The market expectations had fallen to 37 basis points of cuts for this year, as of Wednesday afternoon, or the equivalent of about one and a half more cuts, rather than closer to two.
“It’s confusing,” said Wells Fargo director, rates strategy Michael Schumacher. “The market was pretty bulled up and priced in quite a bit of rate cutting over the next year and a half, and now that has to come out.”
Schumacher said investors were focused on the length of the easing cycle, and Powell’s response was confusing because he clearly made it a shorter-term event.
“He mentioned it a couple times. It’s not like he said it once and goofed and came back to it. So it became hawkish,” said Schumacher. The Fed did not release any new projections at the July meeting, since it releases those forecasts quarterly, so the market was set up to glean any new information from the Fed chief.
“It was pretty evident when you think about this particular meeting was going to be about Powell,” said Schumacher.
Briggs said he still expects the Fed to cut rates.
“If the economy stays the same and prices go down and anything on his list continues to be a risk, I think they will cut, too,” said Briggs. “I tend to think the global outlook is not that great. Germany is going to be a mess for a while. China has issues. The British economy is heading into Brexit and sterling is falling.”
Peter Boockvar, chief investment officer with Bleakley Advisory Group, said Powell also confused the market when he spoke about the Fed helping financial conditions, when it shifted from a rate-hiking policy at the end of last year, to a pause and now to a rate cut.
“He was totally confusing. They’re winging it. And nothing was more clear. You can see the circularity of the problem they’re in,” he said. “They’re talking about easier financial conditions in the first half of the year that was able to sustain the recovery.”.
So by not promising more easing, the Fed could now create shaky market conditions and could find itself taking an easier stance to appease markets, creating a negative feedback loop.
“He’s in quicksand,” said Boockvar. “This is the problem the Fed has put themselves into. They are chasing the tail of the market and the market is the master and the Fed is now the servant.”
It wasn’t just markets that were disappointed with the Fed. President Donald Trump, who had called for a large rate cut, tweeted that the Fed’s rate cut was disappointing and “Powell let us down.”
“It means the pressure is probably not going to subside from Trump, and we’re still going to be in a position where we have a lot of political interference,” said Cabana.