Demands by market actors for accommodative policy linked to a diminished global and domestic economic outlook resulted in a reduction in the federal funds rate by 25 basis points to a range between 1.75% and 2%. In our estimation, this is likely not the final rate cut of 2019 by a central bank clearly concerned with the direction of trade policy, a modest exogenous supply shock in oil markets and political pressure from the executive branch to reduce rates.
Today’s policy decision on the benchmark rate and conflicting signals within the central bank’s communications amid the Fed having to pump $128 billion to quell the disruption to overnight funding markets, reminds one of Joseph Heller’s classic novel, “Catch-22.” Its characters are caught in a series of absurd and mutually conflicting dependencies not of their own making, driven by a series of communications and miscommunications that if not managed properly, leads to tragic consequences.
The combined FOMC policy statement, summary of economic projections and the “dot plot” will likely only add to the confusion around the direction of policy. The fact that seven policymakers, plus presumably, St. Louis Fed President James Bullard, all point to another rate cut, yet the Fed’s SEP forecast on the 2019 fed funds rate implies a 1.9% rate and no further rate cuts, will all play into what is sure to be volatility across asset classes today—exactly the opposite of what is the traditional objective of the central bank.
The FOMC statement was primarily a status quo event with the exception of the following: “Although household spending has been rising at a strong pace, business fixed investment and exports have weakened.” This does tend to imply that the split on the committee is sharp, and does not provide the type of certainty craved by investors, market actors and other policymakers with respect to the path of monetary policy, given the archipelago of risks that appear to be proliferating.
Summary of economic projections
The ‘dot plot” is at the heart of what will surly cause a nasty case of acid indigestion for policymakers, market actors and investors in coming days. The SEP remained largely unchanged, with the exception of a modest increase in the growth forecast to 2.2% from 2.1% in June. However, the internal inconsistency with respect to the eight members who want a rate cut and a forecast that implies no further action this year is a reflection of the current divisions within the Fed.
The three dissents—Boston Fed President Eric Rosengren, Kansas City Fed President Esther George and St. Louis’s Bullard—vividly illustrate the notable divide on the FOMC. Dissents by George and Rosengren were organized around opposition to the rate cut, whereas Bullard’s was organized around a call for a 50-basis-point cut. While dissents are a normal part of the policymaking process at the Federal Reserve, the rise in the number of individuals dissenting, and clear split on the committee, implies that Chairman Jerome Powell’s hold on the group is diminished.
Repo rate, IOER and standing repo facility
The disruption to funding markets this week will require a near-term response by the Federal Reserve. The Fed reduced interest paid on excess reserves by 5 basis points to 1.80, just above the bottom of the range of the policy rate. Given proximity of the disruption to funding markets and the FOMC meeting, we expect more decisive action going forward once the Fed has had time to ascertain the causes of that disruption and to identify the risks going forward. Should the disruption continue, we would expect a reduction in IOER and the construction of a standing overnight repurchase facility to ensure that the liquidity needs of the major money center banks are met and to avoid transmitting the sense that there are risks building in the plumbing of the global financial architecture.