Rarely are central bank meetings as pivotal as this afternoon’s decision by the Federal Reserve, coming, as it does, about a decade after the last rate cut, with global trade and economic growth such a concern.
The U.S. central bank is widely expected to trim interest rates in what would be the first cut since the financial crisis. A cut is considered such a lock that anything less would shock the markets.
As it is, chair Jerome Powell and his colleagues on the Federal Open Market Committee, or FOMC, the central bank’s policy-setting panel, will have to tread carefully lest they upset investors.
Here’s a guide to the decision:
Most market players expect a cut of 25 basis points, or one-quarter of a percentage point, but some think the Fed could go deeper, with 50.
This is also expected to be the first of two or three cuts.
Andrew Hunter, senior U.S. economist at Capital Economics: “The Fed is likely to cut interest rates by 25 basis points … rather than the 50 basis points that some have been calling for. Fed officials will hope that move provides enough ‘insurance’ against the downside risks facing the economy, but we expect a further slowdown in economic growth to prompt two more 25-basis-point cuts, in December and March next year.”
Douglas Porter, chief economist at Bank of Montreal: “We believe that this will ultimately be a mini easing cycle, officially calling for just one more move in October, although the market is priced for roughly 100 basis points of cuts over the next year. The deciding factor for whether the rate cuts morph into a major cycle, not surprisingly, will be how the underlying economy fares in the next six to 12 months.”
How will they play it?
Bipan Rai, North America head of foreign exchange strategy at CIBC World Markets, and his colleague Sarah Ying, associate, foreign exchange strategy, said there could be one of two approaches by Mr. Powell and his colleagues.
Approach #1: “The first is that the Fed will wax more dovish in the statement to justify the cut and to leave open the option to ease again later in the year if need be. There are enough concerns with respect to global trade and core [personal consumption expenditures] to justify that path. An emphasis on needing to ensure that the economic expansion is sustained is an example of something to look for in the statement in this scenario.”
Approach #2: “The second is the ‘hawkish cut’ scenario in that the Fed isn’t as dovish as anticipated and leaves the market to reprice expectations going forward. The data since June have been more constructive and market-based inflation expectations have recovered. Additionally, the Fed may want to avoid sending the message that a prolonged slowdown is around the corner, so maintaining a whiff of insurance to this cut is important. Introducing words like ‘patience’ back into the statement would reinforce the data-dependent nature of the Fed and that the September meeting shouldn’t be considered a lock for a rate cut that the market is expecting now (just under 50 basis points of easing are priced by end of September). This is the path that we envisage the Fed leaning towards.”
What about the president?
President Donald Trump has been on the Fed’s case for some time now, pressing the central bank for deep rate cuts and complaining about the strength of the U.S. dollar.
Politicians aren’t supposed to wade into monetary policy, but Mr. Trump is hardly traditional and, analysts believe, is sure to have something to say should the Fed cut by just one-quarter of a point, as expected.
Kit Juckes, global fixed income strategist, Société Générale: “Markets have very rarely been surprised by FOMC decisions of late, such as the degree of guidance we receive. This time around, the guidance points to a 25-basis-point cut now, with an open door for more cuts later. That will surely disappoint the president.”
CMC Markets chief analyst Michael Hewson questioned whether the Fed should be cutting rates at all, and also suggested the central bank’s credibility is “on the line.”
The Fed, he noted, has oft said it would be guided by economic data, and this appears generally to have been the case since the financial crisis.
But, said Mr. Hewson: “This narrative appears to have undergone a marked shift in the past few months, and in some respects it’s not hard to see why, with political pressure to cut rates at abnormally high levels, and a global economy that is struggling to maintain momentum. At the end of last year, the real concern was that the Fed was tightening too quickly, in the face of growing storm clouds, however the central bank quickly realized that to do such a thing might well be a mistake. Now it appears that the Fed is about to embark on a rate cut, which to all intents and purposes looks like an attempt to mollify a U.S. president who has his own agenda, and who thinks the central bank is a tool for his own political ends. Quite simply, the current data in no way warrant a rate cut, whether it be 25 basis points or 50 basis points, with trend growth much higher than when the Fed started its hiking cycle and unemployment which is still near multiyear lows.”
How might markets react?
Markets have been moving up and down on comments by Fed officials and speculation of what the central bank will do this afternoon and going forward.
This also comes after the European Central Bank disappointed investors by holding off on stimulus until September.
Eric Lascelles, chief economist at RBC Global Asset Management: “The Fed will have to operate carefully if it does opt to deliver ‘just’ a 25-basis-point rate cut. The Fed probably won’t want the stock market to sell off on the day of its very first rate cut. The whole point is to boost growth and sentiment. While a 50-basis-point cut isn’t truly ‘expected,’ it is partially priced in. Thus, the Fed will likely have to insert some more stimulative language into its statement and trailing press conference to keep markets content even as they price out the glimmer of a 50-basis-point move.”
Paul Ashworth, chief U.S. economist, Capital Economics: “The upshot is that after a week when the ECB disappointed the markets – even though it strongly hinted that a rate cut and more quantitative easing were coming soon – the Fed risks a similar market reaction if it cuts rates by only 25 basis points, particularly if one or more hawks dissent.”
BMO’s Mr. Porter: “Perhaps the single biggest takeaway from past easing cycles is that equities have tended to rise six months after the rate cuts began while bond yields have been nearly flat on average – both in mini and in major easing cycles. In seven of the 12 cycles, the S&P 500 has posted double-digit advances in the following six months. However, note that the two most recent cycles have run against that grain.”
Then there are currencies.
CIBC’s Mr. Rai and Ms. Ying: “The market is already priced for [25 basis points], so once again, projected [foreign-exchange] moves will come off the nuances of the statement and whether it justifies what the market is already pricing in for the rest of the year (which is just under three cuts by the end off the year).”
Société Générale’s Mr. Juckes: “A 25-basis-point cut is universally expected, more than that is unlikely, but the tone of the accompanying remarks and the presidential reaction, will help form the market reaction. So though, in [foreign exchange] at any rate, growth expectations have mattered more than rate moves and if lower rates increase optimism about the U.S. economy, they won’t weaken the dollar much.”
Mr. Juckes: “The big danger of course, is that the Fed eases, sounds dovish, but doesn’t do enough for the president and worse still, the [foreign exchange] market doesn’t co-operate and weaken the dollar. At that point, he’ll surely repeat his threat to ‘do something about the dollar.’ The yen ought to benefit from ensuing uncertainty, and we like being long [the Canadian dollar] because I can’t see how it fails to gain in that scenario.”
What about the Bank of Canada?
The Bank of Canada is also in a dovish mood, though isn’t poised to cut its benchmark overnight rate, which now sits at 1.75 per cent.
How fast and how deep the Fed goes, however, could affect that.
Many observers believe Bank of Canada Governor Stephen Poloz, senior deputy governor Carolyn Wilkins and their colleagues are content to simply sit and watch developments at this point.
CIBC, however, expects the Bank of Canada to cut its key rate by one-quarter of a percentage point next year. Capital Economics also expects rate cuts in Canada.
There’s also the question of the impact on the Canadian dollar should the Bank of Canada and the Fed diverge too far. Higher interest rates are, of course, loonie-friendly, which is not something the central bank would want to see as it pins its hopes on stronger exports.
Veronica Clark, associate, U.S. economics at Citigroup: “While the Fed is very likely to cut rates by 25 basis points and maintain language that they will be willing to act as necessary to support the expansion in light of downside risks, we continue to think that cuts from the BoC this year are unlikely. Our expectation is that the Fed will lower rates by 50 basis points total this year, with another cut in September. Policy rates in Canada, however, at 1.75 per cent, are already 50 basis points below the lower bound of the estimated neutral range and should continue to be stimulative as global headwinds remain.”
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