A sagging global economy dragged down by a trade war and a domestic manufacturing sector on the edge of contraction are sufficient risks to warrant a 25-basis-point-reduction in the federal funds rate to 2% to 2.25% percent when the Federal Open Market Committee concludes its policy meeting on Wednesday.
In addition, we expect the committee will end its balance sheet reduction program and reduce the interest paid on excess reserves by 25 basis points. Given the sharp differences of opinion among committee members on the efficacy of a rate cut now as opposed to reserving as much monetary firepower as possible for when the current business cycle ends, there will likely be at least one dissenting voice coming from Kansas City Federal Reserve President Esther George, Boston Fed President Eric Rosengren or FOMC Vice Chair for Supervision Randal Quarles.
The Federal Reserve’s expected move comes amid a major week of pending policy decisions by global central banks including the Bank of Japan, the Bank of England and the Central Bank of Brazil, in addition to ongoing trade negotiations between the United States and China. Just as important, the July Manufacturing ISM report from the Institute of Supply Management will be published on Thursday and the July U.S. employment report will be released on Friday, setting up the week as the most important for policymakers, investors and corporate executives in some time. The Fed’s policy statement and the subsequent press conference with Fed Chair Jerome Powell will be refracted through a global economic prism that will elicit further questions about the direction of trade and monetary policy for the remainder of the week.
While we expect no change in the June forward guidance and for the Fed to retain the phrases “will closely monitor” and “will act as appropriate,” we think the committee will err on the side of caution in its post-meeting statement, noting weak fixed-business investment and a milder economic outlook. We also expect no change on the language describing inflation.
At the June meeting, Powell chose to signal a coming rate cute and was far move dovish than the Fed’s statement implied. During this week’s post-statement press conference, we expect to see a bit more disciplined Powell, given the sharp differences on the committee over a rate cut in July much less an additional cut in September. Our base case remains that the FOMC will cut rates twice this year by 25 basis points (in July and September) and we anticipate that Powell will accentuate growing global risks and the contraction in capital expenditures in his live comments to support the Fed’s policy decisions.