Monetary policy is difficult under the best of circumstances. The cross currents of the trade war, a modest exogenous supply shock in oil markets, political pressure from the executive branch to reduce interest rates and former colleagues suggesting the Federal Reserve get political make the rate decision resulting from the upcoming FOMC meeting one of the more challenging in some time. Adding to the difficulty is a divided Fed that is an institution under pressure, and at risk, yet it remains the only game in town, given the heightened political polarization between the executive and legislative branches. Thus we expect the Federal Open Market Committee will reduce the federal funds rate by 25 basis points to a range of 1.75% to 2% and put forward an economic forecast that notes an aforementioned archipelago of risks to the outlook.
The fissures within the Fed will be vividly on display inside its policy statement due to the expected hawkish dissents put forward by Boston Federal Reserve President Eric Rosengren and Kansas City Fed President Esther George. Those fissures are the major reason we do not expect to see any material change in the summary of economic projections on growth or inflation, and no indication of further rate cuts this year within the median interest rate dot plot despite growing market expectations that the Fed will cut rates in October and December. However, we do expect a modest increase in the expected unemployment rate in 2020 and 2021.
Doves vs. hawks
The policy paragraph within the Fed’s statement should not materially change its previous statements reflecting “uncertainties about the outlook,” and that the Fed “will continue to monitor” and “act as appropriate to sustain the expansion.” Our expectation is that the doves on the committee will prevail, but any change in the language will likely be interpreted as a victory by the hawks and could cause sharp movements the price of risk assets following the publication of the statement.
In our estimation, the continued dour global and domestic manufacturing data and the supply shock to global oil markets over the weekend will present Chairman Jerome Powell the opportunity to instill some discipline through the statement and the summary of economic projections to his divided committee. In addition, it will provide Powell an opportunity to further clarify in the ensuing press conference on the meaning of a “mid-cycle adjustment.” Perhaps more importantly, Powell will use the forum to distance himself from the recent statement by former NY Fed Chair William Dudley about the Fed getting political.