The Daily Update - Fed Carefully Watching

As expected, the FOMC cut the fed funds target range by 25 bps to 1.75-2% and the statement noted that while the Committee views the most likely outcome as one of ‘sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective’ but they also acknowledged that ‘uncertainties about this outlook remain’. The decision is a ‘hawkish cut’: the latest median dot plot shows no further rate cuts this year or in 2020 and today’s decision was split with Ester George and Eric Rosengren dissenting on the decision to cut rates and James Bullard dissenting as he thought a 50bps cut was more appropriate.

The futures market continues to price in a further rate cut but USTs traded slightly weaker into yesterday’s close and the dollar strengthened. Meanwhile, Donald Trump took to twitter vexed that the rate cut had not been larger tweeting: ‘Jay Powell and the Federal Reserve Fail Again. No ‘’guts,’’ no sense, no vision! A terrible communicator!’

At the press conference, Jerome Powell noted the consumer ‘is in strong shape’ while the manufacturing side is weaker but he sees US growth as solid and close to GDP forecasts of 2% although geopolitics, slowing global growth and trade policy uncertainty remain key risks to this outlook. Thus, the Fed was not on a ‘pre-set course’ but was carefully watching how events evolve and, while it was not their base case, remained open to a ‘more extensive sequence of cuts’ if required. When asked about using negative rates Powell indicated a preference for other policy options noting: ‘If we were to find ourselves at some future date again at the effective lower bound, again not something we are expecting, then I think we would look at using large scale asset purchases and forward guidance,’ which he said he felt ‘worked fairly well’ in the financial crisis.

Following on from the spike in the repo rates earlier in the week and the effective fed funds rate breaching its ceiling, the Fed also cut the IOER (interest on excess reserves) and the reverse repo rate by 30bps to 1.8% and 1.7% respectively. At the press conference Powell stated that they were: ‘very closely monitoring market developments and assessing their implications for the appropriate level of reserves’ and ‘we’re going to be assessing the question of when it will [be] appropriate to resume the organic growth of our balance sheet.’

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