An Insurance Cut with an Optionality Clause
by Craig Dismuke, Dudley Carter
The FOMC voted to cut its target rate range from 2.25-2.50% to 2.00-2.25%, lowered its interest rate on excess reserves from 2.35% to 2.10%, and elected to end its balance sheet runoff on August 1 rather than waiting until September 30. This is the first rate cut since 2008 and comes amidst growing concerns regarding the weakening pace of global growth, the uncertain impact of trade tensions on the U.S. economy, and the persistence of below-target inflation. As stated in the FOMC Statement, the decision was made in light of “the implications of global developments for the economic outlook as well as muted inflation pressures.” While the uncertainties have increased to an actionable level for Fed officials, the U.S. economic data broadly point to continued resilience, primarily on the strength of the consumer and federal deficit spending. Given this resilience and presuming trade negotiations do not spiral downward, this policy change is more likely to be the beginning of small policy tweaks aimed at balancing the risks rather than the beginning of an easing cycle.
The text of the Statement reflects only minor changes relating to the economic assessment. However, the forward policy communication was changed. Previously the Statement said that the Committee would “closely monitor the implications of the incoming information for the economic outlook and will act as appropriate to sustain the expansion.” The July Statement was amended to say, “As the Committee contemplates the future path of the target range for the federal funds rates, it will continue to monitor the implications …”. We read this as leaving the door open for another rate cut; but, also giving the Committee optionality on the direction of the next policy change.
The Committee also decided to end its portfolio runoff earlier than initially prescribed. The portfolio runoff will now end on August 1, at which point all cashflow will be reinvested. Mortgage or agency cashflows up to $20 billion per month will be reinvested into Treasurys with a target duration matching the existing portfolio’s. Any mortgage or agency cashflow exceeding $20 billion will be reinvested into mortgage-backed securities.
Notably, there were two dissenters to cutting the target rate range, Kansas City Bank President Esther George and Boston Bank President Eric Rosengren. Having two voting members dissent seems to lower the odds of another rate cut at the Fed’s September meeting. Nonetheless, the door has been left open to future rates cuts (or hikes).
Fed Chair Powell will further explain the decision in his 1:30 p.m. CT press conference.
FOMC Official Statement
July 31, 2019
Information received since the Federal Open Market Committee met in June indicates that the labor market remains strong and that economic activity has been rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although growth of household spending has picked up from earlier in the year, growth of business fixed investment has been soft. On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain. As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.
The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated.
Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; James Bullard; Richard H. Clarida; Charles L. Evans; and Randal K. Quarles. Voting against the action were Esther L. George and Eric S. Rosengren, who preferred at this meeting to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent.