While there was no change to the target Fed Funds rate at the Federal Reserve Meeting concluding on June 19, the Federal Open Market Committee (FOMC) signaled to the market its continuation toward a more accommodative path. As a result, expectations of rate cuts in the second half of the year increased in probability and magnitude. The stock and bond markets reacted favorably, with the S&P 500® rising just under 1% the following day to reach a record high and the 10-year Treasury bond yield falling to an intra-day low of 1.97%, its lowest level since September 2017.
Here are some of the key takeaways interpreted as conducive to future rate cuts:
- The statement contained 362 words, 79 of them being new ones, representing evidence of the Fed’s evolving perspective. None of them garnered more attention than the removal of the word “patient,” which was replaced by “closely monitor” in regard to how the committee “will act as appropriate to sustain the expansion.” Investors may recall it was the inclusion of the word “patient” back in January that incited market optimism regarding last year’s tightening cycle being placed on hold. Hence, the Fed life cycle of the word “patient” is one that is hailed when added to language about potentially raising rates, and equally hailed when being removed from language about reducing them.
- In addition to the statement’s language, the official Fed Dot Plot quickly communicated expectations within the FOMC that rates are likely to come down in the remaining months of this year. The Dot Plot is an anonymous survey taken of committee members as to where they see future Fed Fund ranges at the end of each of the next three calendar years. While it certainly varies over time, it is viewed by many as the best snapshot of the Fed’s collective thinking at any given moment in time. With this in mind, the June snapshot changed noticeably and dovishly.
- This new Dot Plot now shows eight of the 17 committee members believe there will be at least one Fed Funds rate reduction of .25% between July and December, and seven of those eight believe there will be two rate reductions totaling .50%, potentially bringing the target range to 1.75%–2.00%. This was a dramatic change from March when none of the committee members expected a rate cut for the 2019 calendar year, and six expected increases of .25%–.50%. Furthermore, during the post-meeting press conference, Chairman Jerome Powell expressed that many of those members not currently forecasting a rate cut “agree that the case for additional accommodation has strengthened since the May meeting.”
- This has led some to speculate that the July 30–31 meeting could actually see a .50% reduction in the Fed Funds rate. We would view such conjecture as premature, particularly in light of the fact we have the June Employment Report, 2Q gross domestic product (advanced estimate), and the much anticipated G20 Summit in which Presidents Trump and Xi Jinping are expected to renew trade talks. Nonetheless, the fact that a .50% reduction is even being speculated at this point speaks volumes about how far the Fed has come in recent months.
- Expectations of rate cuts by the Fed between now and year end have increased following the June meeting. Fed Funds futures markets are currently forecasting a better than 90% probability of .50% in rate reductions by December and a 70% probability of .75%. Much will need to play out in upcoming weeks and months to see if these market-based forecasts prove to be intuitive or overly optimistic.
It is our feeling that we will likely see either two or three reductions of .25% in the Fed Funds target range, putting the lower bound at between 1.50–1.75%. This is predicated on three broad criteria we believe the Fed is likely to be watching in the days ahead:
- Direct concern about the ongoing trade dispute with China and how the downstream effects of current and pending tariffs might ultimately impact the economy
- The bias of the Fed to err on the side of accommodation so to avoid a recession — and one history may remember as being Fed-induced
- The desire to avoid an inverted yield curve for an extended period of time, which may continue to fuel recessionary fears and even self-fulfilling investment or consumer behavior
So in summary, while this may have sounded beyond the realm of believability as recently as the last time most of us sang “Auld Lang Syne,” we are now officially on the verge of an easing cycle. Oh, how the winds at the Fed can change.
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