As expected, the Federal Reserve cut the target range on the Fed Funds rate by 0.25% at the conclusion of its July 31 meeting, taking it to a range of 2.00–2.25%. Following the meeting, stocks turned negative as the Dow Jones Industrial Average, S&P 500®, and NASDAQ fell by more than 1%. Long-term interest rates declined, as well, with the 10-year Treasury yield dropping 4 basis points to 2.02%. In this immediate aftermath, we believe the following points are pertinent:
- Markets took a sharp intra-day turn to the downside during Chairman Jay Powell’s post-meeting press conference when he used the words “mid-cycle adjustment to policy,” which the market quickly interpreted as being more hawkish than expected and perhaps indicative that more rate cuts were less likely than had been expected at the day’s outset. On two occasions later in the press conference, Chairman Powell sought to clarify that terminology by saying the Fed was not embarking on a “long-rate cutting cycle.”
- As we have expressed in the Transamerica Mid-Year Market Outlook Clearing the Path, we believe the Fed has begun what we would call a mini-easing cycle of two or three rate cuts, including the one implemented July 31. This, in our opinion, is consistent with what Chairman Powell said in the press conference, and we still believe we will likely see a further reduction in the Fed Funds rate in September and/or December.
- Such actions would also be consistent with what Chairman Powell identified as the three predominant criteria behind the decision to reduce the Fed Funds rate, those being a slowing pace of global growth, uncertainties pertaining to U.S. trade policy, and inflation rates that remain consistently below the Fed’s target of 2%.
- What we find most important is we do not see any of these three elements materially changing in the months ahead, and we therefore believe another rate cut in September remains a high probability. With December perhaps still on the table after that, we would say there’s nothing about the July 31 Fed statement or press conference that changes our perspective on a total of two or three rate cuts for the year.
- Between now and year end, we see the yield curve steepening modestly and moving away from being inverted, but still remaining narrow. We believe the 10-year Treasury yield will be capped in the 2.20–2.40% range for the foreseeable future if for no other reason than the long end of the curves in Europe and Japan remaining mired in a negative rate environment. In the short term, lower rate momentum could push the 10-year yield into the 1.80% range.
- We feel most of the post-meeting downside volatility on July 31 was likely attributable to specific wording used by Chairman Powell in the press conference, which in our opinion was over-interpreted by the market. Therefore, we continue to believe a mini-easing cycle, meaning perhaps one or two more rate cuts, could occur between now and year end.
In regard to the equity and credit markets and as we have stated in our 2019 Mid-Year Market Outlook, we continue to believe a “Goldilocks” environment could be shaping up for 2020. By “Goldilocks,” we mean an economy running “not too hot or cold,” perhaps in the 2–2.5% range, accompanied by low inflation, lower interest rates, and the prospect of double-digit corporate earnings growth. We believe this to be a realistic outcome. However, it would be in part predicated on a resolution to the U.S.-China trade dispute, which we believe remains the single biggest risk to investors over the next year.
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