Fed Preview: Caught Between Pride And Pragmatism On Speed, Frequency Of Cuts

Investors may feel like they have Federal Reserve policymakers on the run after getting them to pivot first from steady increases in interest rates to patient no-change in policy to ready to cut rates if appropriate. The Fed futures predictor puts the odds of a cut at the two-day meeting beginning today at 20%, though that is down from 25% at one point.

But some of the Federal Open Market Committee (FOMC) members may be inclined to dig in their heels, not wanting to be chased around by market participants, let alone tweeting presidents. The odds are decidedly against a cut this week, and a move at the next meeting at the end of July is anything but a foregone conclusion, even though futures say chances are 68% in favor of a cut to 2.00-2.25 from the current 2.25-2.50.

Fed chair Jerome Powell will once again have to walk the tightrope at the press conference Wednesday to avoid adding to the momentum counting on a cut in July while also not dashing hopes to the extent of provoking a market backlash.

Forward guidance, which was designed to calm market worries by guaranteeing normal times would return, faces unprecedented challenges in preparing investors for a world that may never be normal again. Take the dot-plot graph of individual policymakers’ projections of where interest rates will be in coming months. Can it even function when interest rates may decline?

Despite all the jitters over trade, data doesn’t give monetary policymakers a clear idea of where things are going. The economy added only 75,000 jobs in May, 100,000 fewer than the consensus forecast, but industrial production was up 0.4% in the month, double the consensus forecast.

The data on inflation is less ambivalent. Consumer Price Inflation ran at an annualized 1.4% in May, well below the Fed’s 2% target. CPI tends to run a little higher than the Personal Consumption Expenditure measure preferred by the Fed, so that is unlikely to support Powell’s contention that transitory factors are dampening inflation. Inflation expectations tracked by the University of Michigan fell to 2.2% in June, the lowest ever, while prices on inflation-protected bonds implied a rate of 1.65% over the next decade.

The inverted yield curve is somewhat less clear. While the yield on 3-month Treasury bills moved ahead of that on 10-year Treasuries in March, and remains inverted as of this writing, the 2-year/10-year curve has yet to go negative. For some, this confirms the Fed will indeed embark on preemptive rate cuts to reverse the inversion in the short term.

Powell fueled these hopes last week when he abandoned his patient stance and assured his audience at a monetary policy strategy conference that the Fed “will act as appropriate to sustain the expansion.” Coming on the heels of the previous day’s remarks from St. Louis Fed president James Bullard that trade tensions could mean “a downward policy rate adjustment may be warranted soon,” it was all the encouragement investors needed to think the Fed was finally getting it right.

In their enthusiasm, market participants, taking a July cut for granted, see better than even chances of a second cut in September, to 1.75-2.00, and a 35% chance of a third cut down to 1.50-1.75 in December.

A lot of things would have to go wrong for that scenario to come to pass. The imponderable in all this is how the Fed responds to pressure from the White House to cut rates. Will it resist cuts—even against its own better judgment—in order to appear independent, or will it be truly independent and preempt a softening of the economy by cutting rates successively and eating crow?