Powell Tempers the Fed’s “Hawkish Cut”
While the Fed met expectations in its latest interest rate reduction, it signaled that hikes are a long way off.
The U.S. Federal Reserve cut its benchmark target rate a quarter point to a range of 1.50% to 1.75% at its end-October meeting, matching market expectations. But Fed Chairman Jerome Powell took revised language in the monetary authority’s post-meeting statement a little further to suggest a neutral policy bias, meaning no further easing or tightening anytime soon.
In delivering the expected “hawkish cut,” the Fed’s post-meeting communique replaced “will act as appropriate” from the prior meeting to assess “the appropriate path.” That suggested a shift from an easing bias to a pause in accommodation, causing risk assets to wobble as markets had been pricing in a fourth cut by year end.
But it didn’t take stocks long to bounce back, with the S&P 500 Index rising 0.4% to finish the session at a record high. Gold stumbled before gaining ground, while the 10-year U.S. Treasury yield went in the other direction, initially rising and then drifting lower as the dollar slightly weakened. If the Federal Open Markets Committee (FOMC) statement initially disappointed investors in conveying that more cuts weren’t on the way, Powell made clear in his post-meeting comments that neither were hikes, which would require “a really significant move up in inflation that’s persistent.” He repeatedly suggested that “the current stance of monetary policy is likely to remain appropriate.”
U.S. economic growth in the third quarter grew at a moderate, if somewhat faster-than-expected 1.9% annualized pace, down from 2.0% in the second quarter, government data out earlier in the day showed. The latest Fed cut supports “sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2% objective,” the FOMC said in its statement, adding that “uncertainties about this outlook remain.”
The Fed likely views the cut as additional insurance against slowing growth and lower inflation expectations. Upon taking the podium to address the media, though, Powell immediately declared that monetary policy is “in a good place” and noted “risks moved in a positive direction between meetings.” He pointed to recent, reduced tensions on trade and Brexit. But we know how fickle both the U.S. and China have been in negotiations, so trade risk could ramp back up very quickly.
As for market reaction, if money market and shorter-term floating interest rates ebb in tandem with the Fed funds rate cut, the Fed has little control over longer-term rates. Investors, just like FOMC members, will have to watch how global and U.S. growth, trade policy and inflation expectations develop. Because monetary policy acts with a lag, we have to wait and see what impact, if any, the latest cut will have on the economy.
It’s appropriate for the Fed to signal no further near-term cuts. The U.S. economy is at full employment, inflation is close to the 2% target. Moreover, while Powell said the financial system isn’t suffering any “large imbalances” such as high financial sector leverage, funding risks, or asset price bubbles across a range of industries, he noted that corporate leverage is at historically high levels. All that suggests no October Fed funds cut would also have been appropriate.
The U.S. economy will see another recession at some point. Since we are unlikely to see any rate hikes in the near future, the Fed is left with very limited firepower to fight the next downturn if it materializes sooner than expected.