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Fed Lifts Threshold Against Further Rate Cuts

Karl Schamotta November 20, 2019

Federal Reserve officials called monetary policy “well-calibrated” after cutting rates for a third time last month – while raising the bar to further monetary loosening by saying that a “material reassessment of the economic outlook” would be needed to trigger additional action.

A record of the rate-setting committee’s October 29-30 meeting released this afternoon shows that officials “generally viewed the economic outlook as positive,” and that “uncertainties associated with trade tensions as well as geopolitical risks had eased somewhat, although they remained elevated”. A rate cut was approved because, “Risks to the outlook associated with global economic growth and international trade were still seen as significant. The risk that a global growth slowdown would further weigh on the domestic economy remained prominent”.

At the meeting, Fed officials elected to cut the target range to 1.5%, but shifted their communication stance into neutral by removing the “act as appropriate to sustain the expansion” language that had been found in the three previous statements – suggesting that the ‘mid-cycle adjustment’ has reached its conclusion.

Several participants recommended adding additional language that would make additional rate cuts “unlikely in the near term unless incoming information was consistent with a significant slowdown in the pace of economic activity”. This was rejected, but the sentiment was reinforced when Chairman Jerome Powell told Congress last week that rates were now at an “appropriate level”, and that it would take a “material reassessment” of the fundamentals to prompt a change.

Given that a number of Fed officials have been on the speaking circuit since the meeting, today’s release is unlikely to impact markets in any material way. Implied interest rate expectations remain stable as we go to pixels, with federal funds futures priced for one more cut by the end of 2020. Yields and exchange rates are largely unmoved.

More broadly, financial markets appear increasingly convinced that the central bank’s three “insurance cuts” are sufficient to pull the global economy out of a tailspin. Key industrial production indicators in Germany, Japan, and the United States have improved over the last month, dragging oil prices upward, while putting pressure on safe haven instruments. With consumers continuing to spend, yields have climbed upward from lows reached earlier in the year, and equity markets have surged to new highs.

The Fed’s efforts to calm stresses in the funding markets are also playing a role, with new repurchase operations and a cumulative $250 billion in Treasury purchases since August helping to reduce risk premia. With this programme expected to increase in tempo into the critical year-end period, the core of the global financial system has been flooded with liquidity.

But substantial risks remain – and could yet trigger a reversal in sentiment that lifts safe havens and hurts economically-sensitive currencies before the year draws to a close.

Although major economies are slowing less quickly than they were a few months ago, they’re still slowing. Improved financial conditions may cushion the landing, but are unlikely to fully offset lagged trade war effects. A recession no longer looks imminent, but risk levels remain elevated.

A seemingly-constructive turn in trade talks also looks vulnerable today, after the US Senate unanimously approved a bill that would require the State Department to annually certify that Hong Kong remains sufficiently autonomous from Beijing to justify special privileges – a move that, if passed into law, could potentially derail negotiations.

And of course, the Trump Twitter feed remains active.

‘Nuff said.

Karl Schamotta
Chief Market Strategist
@vsualst

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