The Market Today
Fed Cuts and Leaves Door Open, Powell Fumbles Explanation
by Craig Dismuke, Dudley Carter
Vining Sparks’ Chief Economist, Craig Dismuke, appeared on Fox Business this morning discussing the challenges for monetary policymakers in a low-interest rate world and expectations for future policy decisions. To view the video, click here.
Jobless Claims Remain Low: Initial jobless claims for the week ending July 27 rose from 207k to 215k bringing the four-week moving average down to 211.5k, the fourth-lowest of the year. The labor data continue to point to few layoffs and modest, albeit slower, job growth.
Data Tracking Recently Weak Sectors of Economy on Today’s Calendar: The remainder of the day brings another round of important data including manufacturing activity, construction spending, and auto sales. At 9:00 a.m. CT, the ISM Manufacturing Index is expected to inch up from 51.7 to 52.0, remaining one of the few industrialized nations with an above-50 manufacturing PMI: Canada (49.2), Mexico (49.2), France (49.7), Germany (43.2), Italy (48.5), Russia (49.3), U.K. (48.0), China (49.9), Japan (49.4), and South Korea (47.3), to mention a few (see Chart of the Day). Also at 9:00 a.m., construction spending is expected to have increased 0.3% MoM in June. Construction activity has been soft recently, down 2.3% YoY on an 11.2% decline in private residential activity. July’s auto sales data will be released throughout the day and are expected to have declined from 17.3 million units annualized to 16.9 million. Since peaking in 2017, sales have been on a declining trend ever since.
Yesterday – Clumsy Press Conference Created Significant Afternoon Volatility: The first half of Wednesday’s trading will be forgotten because of the significant volatility that transpired in the afternoon. By comparison, stocks flatlined during morning trading and Treasury yields held lower as investors awaited confirmation of their expectation for a lower Fed Funds rate. The initial response to the Fed’s rate cut was relatively subdued, with stocks weakening slightly and yields jumping after the Official Statement repeated the seemingly dovish phrase that the Committee “will act as appropriate,” but showed two hawkish dissents and language which could be read to reflect more optionality (including hawkish optionality) for the forward rate path than markets wanted (more below). But the wheels fell off the wagon during Chair Powell’s press conference as he clumsily explained the Fed’s reaction function to hard-to-quantify effects of weaker global growth and trade tensions, leaned heavily on the idea of this being an insurance “mid-cycle adjustment,” pushed back on the idea that this was the start of a “lengthy cutting cycle.” Treasury yields spiked on those remarks and the major stock indices tumbled. The 2-year Treasury yield surged nearly 12 bps within minutes as the S&P 500 sank from down 0.1% on the day to down 1.8%. After an anxious twenty minutes, yields fell back and stocks recovered as Powell clarified in an answer to a subsequent question, “Let me be clear, what I said was it’s not the beginning of a long series of rate cuts. I didn’t say it’s just one, or anything like that.” While it ended off the lows, the S&P 500 closed down a disappointing 1.1%. The 2-year yield settled back to up just 2.6 bps while the 10-year yield fell 4.4 bps, flattening the related spread to a two-month low of 14 bps. Equally important, the Dollar strengthened to a 26-month high as investors reassessed likely Fed actions for the remainder of the year.
Overnight – Fed’s Cut to Guard Against Global Risks Precedes Contractionary PMIs in China and the U.K.: Treasury yields moved higher overnight and U.S. stock futures recovered as investors continued to digest the Fed’s rate cut aimed at protecting the U.S. economy from downside risks it sees emanating from abroad. Signs that those risks remain were evident in developments Thursday in both Asia and Europe. Chinese stocks were among the worst performers after a second July manufacturing survey this week turned up more than expected, but showed activity continued to contract. Trade tensions and weakness in China were a major reason behind the Fed’s decision, as was the slowdown in Europe. Brexit is obviously affecting growth there and among the global risks on the minds of Fed officials as they assess the outlook. It also helps explain a third consecutive month of contraction in the U.K.’s manufacturing sector, as evidenced by the Markit PMI holding steady in July at its lowest level in more than six years. This host of factors were prevalent in the Bank of England’s decision to keep rates unchanged for now, but highlight that “trade tensions have intensified,” “global activity has remained soft,” and “increased [Brexit] uncertainty…means the economy could follow a wide range of paths.” Around 7:15 a.m. CT, the 2-year yield was 1.4 bps higher, the 10-year yield was up 2.1 bps, and equity futures had strengthened between 0.1% and 0.2%.
An Insurance Cut with an Optionality Clause: Amidst growing concerns about global growth and trade policies, and against a backdrop of below-target inflation, the FOMC voted to cut rates for the first time since 2008, lowering its target range from 2.25-2.50% to 2.00-2.25%. Additionally, they lowered the interest rate on excess reserves from 2.35% to 2.10% and elected to end balance sheet runoff two months early on August 1. As stated in the FOMC Statement, those decisions were made in light of “the implications of global developments for the economic outlook as well as muted inflation pressures,” despite broadly resilient U.S. economic data. The economic assessment was changed very little, but the forward policy communication was altered to say the Committee will “continue to monitor…incoming information…and will act as appropriate” as it “contemplates the future path of the target range,” (new language emphasized). Notably, there were two dissenters to cutting the target rate range, Kansas City Bank President Esther George and Boston Bank President Eric Rosengren. The real market action, however, was saved for the confusing press conference in which Powell struggled to clearly lay out a formula to follow for determining why the Fed was cutting rates and what the next step might be.
Bottom Line: We read the updated forward guidance as leaving the door open for another rate cut; but, also giving the Committee optionality on the direction of the next policy change. Given the economy’s resilience and presuming trade negotiations do not spiral downward, Wednesday’s rate cut is more likely the beginning of small policy tweaks aimed at balancing risks rather than the beginning of an easing cycle. In a less-than-graceful press conference, Chair Powell’s ultimate goal seemed aimed at supporting this line of thinking. As to the two dissents, on balance they would seem to lower the odds of another rate cut at the Fed’s September meeting.