The September FOMC could be a turning point. Not through in the actual policy decision, which seems to be a foregone conclusion, but in the hints the Fed provides about the crucial next 18 months. That period covers not just the U.S. presidential election but a potential growth slowdown and even recovery. What does the Fed expect of the economic outlook, and what should we expect of the Fed?
So far the Powell Fed has been reluctant to tip its hand about further rate cuts, and the market has been willing to interpret that generously. The September FOMC will show us whether that arrangement can become a stable pattern or one side or the other ends of shifting their stance.
What to Watch For:
- Rates: Another rate cut of 0.25%, bringing the target fed funds range to 1.75% and 2.0%.
- Dot plot for 2019: A dovish tilt in the distribution, bringing the medians for 2019-2021 modestly lower. The FOMC will feel compelled to respond to the shift in market expectations for further rate cuts, but they won’t think it necessary to confirm market pricing. Since June, the Powell Fed has gotten away with non-committal forward guidance as long as it ultimately delivers rate cuts, that pattern is likely to continue. Thus, the 2019 median should be able to glide down to 1.9% without too much trouble, as long as there is a significant minority of dots lower than that.
- Dot plot for 2020-2022: The dots for the out years are more intriguing, since they cover a period over which the much-feared slowdown should materialize and perhaps pass away. While risks have certainly risen, little else has become more clear about those three years. Without a firm basis for a full-scale reworking of its forecast, the path of least resistance for the Fed will be to take the June dots and mostly just shift them lower. That would imply one more cut in 2020 (for a year-end median 1.6%), following by mild solitary rate hikes in both 2021 and 2022 (year-end medians of 1.9% and 2.1%, respectively).
- Statement of Economic Projections:
- The GDP forecasts should shift slightly lower for 2019 and 2020, in light of continued escalation of trade tensions and further signs that the manufacturing sector is faltering. There’s an outside chance the latter could also lead to a downgrade of the long-run GDP estimate and longer-run interest rates, but don’t expect anything too dramatic. Last week, Fed Chair Powell specifically said, “We’re not forecasting or expecting a recession.” The 2022 GDP projection should be for trend growth.
- The unemployment rate forecasts should be mostly unchanged. In light of the slowing in job growth, the unemployment rate for 2019 could get revised up to 3.7%, but mostly like it will hold steady. The 2022 unemployment rate should show a rise toward long-term unemployment, which could revised down yet again.
- The inflation forecasts should be unchanged in the out years, but headline inflation for 2019 may be revised up to 1.7% in light of the recent pick-up in inflation data.
- FOMC statement on economic conditions: The changes to the description of economic conditions should be modest. Job growth has slowed modestly and inflation has picked up, but otherwise the economic trends are not greatly changed. While inflation expectations have been flagging, the FOMC has proved reluctant to react to anything other broad, consistent trends in that area.
- FOMC statement on policy: As noted above, so far the Powell Fed has been reluctant to tip its hand about further rate cuts. It’s possible that the statement will reinstate language on the balance of risks, but policy makers would probably see that language as too strong of a commitment. It’s more likely that they would instruct their wordsmiths to develop fresh language that suggests any accommodative stance but sounds ambiguous enough to preserve policy optionality. If the Fed does go this route, the phrasing most likely to change is the sentence starting, “As the Committee contemplates the future path of [interest rates]” – this sounded very much like placeholder language, pending further information about the outlook. Well, now the Committee has more information about the outlook. If they’re ready to tip their hands, now’s the time, but neither they nor the market may feel the need to disrupt the status quo. Presidents George and Rosengren are likely to dissent from this second rate cut as well.
- Press Conference: Much of the focus will be on the nature of a “mid-cycle adjustment” and how Powell thinks about risk management at this stage of the economic cycle. Among the most interesting questions the Fed faces now is what do with its dry powder. With only about 200 basis points of easing currently possible, how many of them should it spend on just an insurance policy, as its most recent cut was described and as the next one most likely will too? If the macroeconomic outlook continues to look strained but resilient, at what level of rates would the Fed say, “We’ve done enough mid-cycle adjusting; We need to keep something in reserve in case we need respond to a more drastic and widespread deterioration in the economy”? The Fed could reframe and say that risk management requires a full easing cycle, but that would fit very awkwardly with a rebound in inflation