Soft inflation readings, falling inflation expectations, a deteriorating global economy and slowing overall consumer spending all point to little to no upside risk on the inflation outlook anytime soon.
We expect the Federal Reserve to cut the federal funds rate this week by 25 basis points to a range between 1.50% to 1.75% as the central bank attempts to offset the downward drag of the trade conflict and challenges in the domestic manufacturing sector. But policymakers, investors and firm managers should not expect clarification on the direction of policy in the Federal Open Market Committee monetary statement. Rather, we expect that the Fed will maintain the phrase “will act as appropriate to sustain the expansion.” Given the deceleration in third quarter growth below the long-term trend growth rate of 1.8%, recession in both the manufacturing and agricultural sectors, global economic headwinds and an erratic policy landscape in Washington, this would tend to suggest that the Fed will want leave a December rate cut on the table should conditions not improve.
That being said, Federal Reserve Chairman Jay Powell’s post-meeting news conference is where the trading community will attempt to ascertain if the Fed will end the mid-cycle adjustment after the October rate cut. In our estimation, this may prove a disappointment for investors looking for the all-clear signal, and it is highly probable that Powell sticks to his data-dependence position. In many ways the period between FOMC meetings has strengthened the case not only for a rate cut in October, but a cut in December as well. Soft inflation readings, falling inflation expectations, a deteriorating global economy and slowing overall consumer spending all point to little to no upside risk on the inflation outlook anytime soon. Moreover, given the uncertainty surrounding the so called “phase one” trade deal with China, the Fed has every reason to act to offset the damage to the domestic economy caused by trade policy. In the September FOMC minutes, some participants noted a need for clarity around when rate cuts would end. We think that represents a small, yet loud, hawkish contingent at the Fed. While that may represent one portion of the spectrum of opinion among market participants and policymakers, we do not think that the majority on the committee will bend to that preference and there will be little addition to the forward guidance in the statement. With the committee split into several factions, we expect Kansas City Fed President Esther George and Boston Fed President Eric Rosengren to provide hawkish dissents. We do not expect a second straight dovish dissent by St. Louis Fed President James Bullard.