The Market Today

Fed Cuts and Raises Bar for Future Hikes Or Cuts

by Craig Dismuke, Dudley Carter


Personal Income and Spending Showed Mixed but Stable Results: Personal income growth was a touch on the soft side in September, rising 0.27% MoM versus the 12-month trend rate of +0.40%.  Two notes regarding the September income data, the BEA revised wages and salaries down $1.9 billion (annualized) to account for the UAW strike while farm proprietor’s income was increased $23.3 billion in August (August’s report was revised up from +0.4% to +0.5%) and $12.1 billion in September. On a positive note, disposable income growth was stronger than trend in September due to a drop in tax and non-tax payments; and, when adjusted for inflation, real disposable personal income growth rose an above-trend 0.34% in September. On a year-over-year basis, real disposal income growth is now back up to 3.5% after falling below 3.0% in July for the first time since 2016.  On the spending side, personal spending was slightly weaker than expected, rising 0.2% MoM after a revised-higher 0.2% gain in August.  On a year-over-year basis, personal spending is now back up to 4.0%, pointing to a still-stable consumer sector, albeit slightly weaker than 2018.  With income out-pacing spending, the savings rate inched up 0.2% to 8.3%.  The savings rate remains high and capable of providing some insulation to households in the event of a temporary disruption in income growth.

Jobless Claims Still Show Stable Labor Market: Initial jobless claims for the week ending October 26 rose 5k to 218k, remaining in the 210k-220k band in which they have trended for most of the past four months.  Claims continue to point to a stable labor market.


Markets Fluctuate in Fed Response: As expected, yesterday’s Fed announcement was the major market mover Wednesday as the initial response to the Statement reversed during the inflation-focused press conference of Chair Powell. Two key economic reports released ahead of the open of equity trading both exceeded expectations and briefly pushed Treasury yields higher. ADP’s estimate for private payroll growth printed 125k while a solid quarter for the consumer led to a less-severe slowdown for the broader economy in the third quarter.

Trade Uncertainty Caused Brief Pre-Fed Movement: However, the uptick in yields was short-lived after equities opened lower and a headline hit that Chile had cancelled the APEC Summit it planned to host in mid-November. The cancellation of the summit, where Presidents Trump and Xi were expected to sign the first phase of a trade deal, raised questions about the path of trade negotiations. The White House quickly stated that the timeline of the trade negotiations remains unchanged. Heading into the Fed’s decision, stocks were essentially unchanged while yields held lower.

Hawkish Early Read Faded During Powell’s Press Conference: After the Statement delivered the “hawkish cut” most had expected (more below), shorter yields moved higher while longer yields hardly budged. The initial hawkish interpretation strengthened during Powell’s prepared remarks, but gave way during dialogue on inflation where Powell said he thinks “we would need to see a really significant move up in inflation that’s persistent” before considering a rate hike. With the bar on the data seemingly much higher for a hike, yields reversed lower, sending the 2-year yield down 4.4 bps to 1.60% and the 10-year yield 6.7 bps lower to 1.77%. The S&P 500 jumped to close up 0.3% and near its highs of the day, while the Dollar weakened and gold rose.


China Questions Possibility of Meaningful Trade Deal: Treasury yields had recovered a portion of yesterday’s post-Fed drop during Asian trading, but have since reversed lower on a Bloomberg headline questioning the likelihood of a meaningful U.S.-China trade deal. Global yields had already moved lower prior to the trade news after Fed Chair Powell’s hint yesterday that it would take a significant move up in inflation to justify unwinding any rate cut. However, the European yield drop intensified and Treasury yields turned lower after Bloomberg said “Chinese officials have warned they won’t budge on the thorniest issues” and some officials have “relayed low expectations that future negotiations could result in anything meaningful” unless the U.S. rolls back some tariffs.

Data May Keep Pressure on China to Act: However, the economic data may keep pressure on Chinese officials to act. Overnight, the official manufacturing PMI ticked down more than expected to one if its weakest readings of the cycle, contracting for a six month in a row. The services index also fell more than expected to its second-weakest level since the recession. One of the many considerations behind the Fed’s decision to signal a pause was appropriate, according to Powell, was the observation of “risks to the outlook as perhaps having moved in a positive direction.” He later clarified he was talking primarily about trade. If trade talks breakdown again, it could further weaken global growth and cause the Fed to reassess its pause.

Bank of Japan Hints at Easing if Outlook Worsens: In other news overnight, the Bank of Japan held its policy stance steady but altered its forward guidance to show rates would remain “at their present or lower levels as long as it is necessary” to move inflation to the 2% target. The wording was stronger than that from September which pledged to “maintain the current” rate levels “for an extended period of time, at least through spring 2020.” In Europe, growth across the Eurozone was a marginally-better-than-estimated 0.2% in 3Q, although the 1.1% YoY rate was in line with expectations, and core inflation inched up to 1.1% in October. Germany’s 10-year yield was 5.1 bps lower at 7:30 a.m. CT. A softer core inflation reading steadied the 10-year Treasury yield at down 4.0 bps on the day.


Fed Hits Pause with Shift from Action to Assessment: As expected, to the dislike of Presidents George and Rosengren, the FOMC voted to cut its overnight target rate for a third time to a range of 1.50-1.75%, and lower the interest rate on excess reserves to 1.55%. However, they also appeared to close the door to future cuts for now. The Statement’s moderate economic assessment was essentially unchanged, quickly shifting the focus to the second paragraph’s forward guidance. Instead of pledging to “act as appropriate to sustain the expansion,” language they have used since June, they will now “assess the appropriate path” for fed funds based on the incoming data. The shift from action to assessing implies that they believe they have completed their “mid-cycle adjustment.”

Powell’s Inflation Assessment Declawed the Hawks: Powell’s press conference started with a similarly hawkish tone as he noted, “We believe that monetary policy is in a good place.” While he noted that the moderate growth outlook faces “ongoing risks” from abroad, he again reiterated that “the current stance of monetary policy [is] likely to remain appropriate” absent “developments…that cause a material reassessment of our outlook.” However, he quickly put fears of a near-term reversal of the rate cuts on ice, even if the outlook cleared, by seemingly placing a higher onus on inflation. When asked what the policy response would be if some uncertainties, such as trade, cleared up, Powell answered, “…that’s really about inflation. …So I think we would need to see a really significant move up in inflation that’s persistent before we would consider raising rates.” Bottom line: We expect it will require a meaningful deterioration of economic or financial conditions for the Committee to entertain another rate cut, and a significant uptick in inflationary pressures for them to consider a hike.

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