skip navigation

Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

ECONOMY
August 01, 2019

The Fed Cut Rates Yesterday, but Made No Promises for Tomorrow

By John L. Bellows, PhD

Stay up to date on timely topics and market events. Subscribe to our Blog now.

The Federal Reserve (Fed) cut its benchmark interest rates by 25 bps yesterday and ended its balance sheet reduction two months ahead of schedule. Both moves were widely anticipated.

Fed Chair Jerome Powell hit a number of dovish notes in his press conference. In the opening remarks he talked about the recovery reaching “low- and middle-income communities” and the importance of sustaining the expansion. Powell said the Fed’s estimates of neutral rates have declined. He repeatedly cited low inflation as one of three reasons for easing policy (his other two reasons were slower global growth and trade tensions). Powell said that future hikes are not “particularly likely, frankly.” Finally, Powell tried to thread the needle by giving the impression that more cuts are possible, while at the same time not over-committing to a large number of cuts: “Let me be clear. I said it's not the beginning of a long series of rate cuts. I didn't say it's just one or anything like that.” Clearly, Powell is leaving the door open for more cuts, consistent with the Fed’s latest dot plot, which had a large number of Federal Open Market Committee (FOMC) participants anticipating two cuts this year.

It wasn’t all dovish, however, as Powell did push back subtly on the assumption that the Fed was locked into cutting in September. The post-meeting statement no longer says the Fed will “closely monitor” developments, but instead only says that the Fed will “continue to monitor” developments. Dropping “closely” suggests a little less urgency than there was in June, and therefore less commitment to cutting at the next meeting. (Powell got dangerously close to suggesting the Fed was done cutting when he characterized yesterday’s move as a “mid-cycle adjustment to policy.” This comment caused 2y yields to briefly rise 11 bps to 1.96%. But, Powell then walked that back later in the press conference with some of the dovish bits cited above, causing 2y yields to retrace and settle around 1.87%, up only 2 bps on the day.)

So, in summary, my read of yesterday’s message is essentially: “Still plenty of reasons to be dovish … probably more cuts to come … but we’re not promising that the next cut will come in September.” That is a somewhat nuanced message, and while Powell struggled at times to convey the gradations, I think that’s a reasonable understanding of the outlook, at least as the committee currently sees it.

The sharpest market reaction yesterday was the flattening yield curve, as 2s10s were more than 7 bps flatter on the day. Steepener trades have been popular on the Street recently as some analysts were looking for a 50-bp cut, while others are looking for a move higher in yields due to better growth or inflation. The problem with steepeners, however, has been that the Fed pricing in the front of the curve was very aggressive. Powell’s pushback on a September cut made this pricing look even more stretched, which contributed to the flattening. The market has now repriced somewhat, aided by yesterday’s sharp move, and now there are only 1.5 additional cuts priced in through December. This is slightly above the base case of one more cut, but the mispricing is no longer as extreme as it was a few weeks ago. Stocks were down and the US dollar was up on the day yesterday, both consistent with the Fed not being as dovish as market pricing.

© Western Asset Management Company, LLC 2020. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorised and regulated by Comissão de Valores Mobiliários and Banco Central do Brasil. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority (“FCA”). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK and EEA countries as defined by the FCA or MiFID II rules.