The Market Today
FOMC Decision – To Cut or Wait to Cut?
by Craig Dismuke, Dudley Carter
FOMC Decision – To Cut or Wait to Cut: Vining Sparks’s Chief Economist, Craig Dismuke, appeared on Fox Business this morning discussing the likelihood that the Fed will cut rates at today’s meeting. Futures contracts are currently pricing in only a 20% chance of a cut but August’s contracts are implying a 98% chance of a July 31 cut. The general consensus from economists going into the decision is that the Fed communications will be notably more dovish but that they will stop short of a rate cut.
The Case for Waiting: Speculation is that last week’s strong retail sales report will buoy Fed confidence that the U.S. economy can still weather the uncertainty caused by trade policy. Additionally, waiting until the July meeting will allow Trump and Xi time to advance the stalled trade discussions at the G20 Summit on June 28-29. This, however, presumes that progress will be made. Finally, the president’s recent criticism of Chairman Powell makes cutting rates more difficult as it will give the impression of political partiality.
The Case for Cutting: However, the markets are decidedly convinced that the Fed will eventually cut rates. December’s Fed Funds Futures contracts are currently trading at 1.81%, implying at least two cuts by year-end. One of the greatest risks for monetary policy, currently, is the same issue that surfaced last December (worst December for the S&P 500 since the Great Depression): investors deciding that the Fed is unmoved by conditions that investors deem to be excessively dangerous. Adding to the case for cutting rates, global growth has been weakening since the trade dispute erupted in early-2018, U.S. manufacturing activity finally capitulated to the global trend lower late last year, and other aspects of the U.S. economy appear to be softening more recently. Yet the most significant justification for easing is the perpetually weak inflation data. Core PCE has only topped the Fed’s 2.0% target six times since October 2008 (139 months). Five of those occurrences were in 2012 when oil prices has spiked as high as $126 per barrel. The average rate of core PCE over those 139 months has been a paltry 1.56%. In the most recent report, core PCE was just 1.57%. Further, consumer inflation expectations are the lowest they have been in 40-years of data and market-based inflation expectations are as soft as they have been since 2016. While we expect the inflation weakness will be temporary, the Fed is steadily losing credibility that it will (or can) do what it takes to keep inflation near their 2.0% target.
The Case for Cutting Today: The date of a rate cut is less material than the Fed showing investors that they see the same thing that the markets see. If the Fed does not cut today, we expect they will lower their dots (forward projections for Fed Funds) for 2019, 2020, and the longer-run neutral rate. We also expect their communications to highlight the growing risks and discontentment with inflation. However, the Fed would likely get more bang out of their decision if they were to surprise the markets with a quicker cut than expected. This could limit the number of cuts needed to stabilize sentiment. Moreover, recent research shows that making quick policy decisions yields better outcomes when rates are as low as they already are.
The Decision: The Fed will announce their policy decision at 1:00 p.m. CT along with their Summary of Economic Projections. Chairman Powell will host a presser at 1:30 CT.
Mortgage Applications Tick Lower but Trend Remains Positive: Mortgage applications for the week ending June 14 fell 3.47% on a 3.52% decline in purchase applications and a 3.46% drop in applications for refinance. Despite the weekly decline, the recent trend in purchase applications points to a 2% to 3% gain for home sales in coming months. As Treasury yields have fallen, the 30-year mortgage rate has now fallen from a peak of 5.17% in November to 4.14% according to the MBA report.
Yesterday – Stocks Rose, Yields Swung on Speculation of Easier ECB Policy and Hopes of Trade Progress: U.S. stocks rose Tuesday after President Draghi hinted that the ECB could introduce new stimulus if the outlook doesn’t improve quickly and President Trump announced he will meet with China’s Xi at the G-20. Equity futures had spiked overnight and the indices opened higher after Draghi said “additional stimulus will be required” if risks continue to move to the downside. His remarks sent European equities surging and yields in the region sharply lower. The German 10-year yield closed down 7.6 bps at -0.32%, a new all-time low, while France’s 10-year note dropped 9.8 bps to 0.00% for the first time ever. Those moves had dragged the 10-year Treasury yield down as many as 8 bps to low as 2.01%, the lowest since President Trump’s election, before the president’s tweet on trade. Yields jumped with equities after President Trump announced he and China’s Xi had a “very good” phone conversation and the two will have “an extended meeting” at next week’s G-20 summit in Japan. The yield curve shifted up off its lows, leaving the 2-year yield 0.4 bps lower at 1.86% and the 10-year yield down 3.5 bps at 2.06%. The S&P 500 finished up 1% while the Dow and Nasdaq both gained 1.4%.
Overnight – U.S. Equities Calm, Treasury Yields Tick Higher Before the Fed: Global equity markets were mixed on Wednesday while sovereign yields generally moved higher ahead of this afternoon’s Fed announcement. European bourses and U.S. equity futures hovered around unchanged despite a strong start in Asia. The major Asian indices jumped sharply on the news that Presidents Trump and Xi will meet at next week’s G-20 summit to discuss trade. Japanese trade data released overnight became the latest global report to echo the urgency of a trade deal for the sake of global economic stability. Japanese exports in May were down 7.8% from one year ago and have declined in six consecutive months amidst heightened uncertainty. Japan’s 10-year yield fell 1 bp Wednesday to -0.14%, the lowest since August 2016. And while investors expect the Fed to tilt toward a more dovish policy posture, Treasury yields inched higher overnight after yesterday’s ECB-induced downside volatility. With yields higher across most of Europe, Treasury yields tacked on between 3 and 3.5 bps to push the 2-year yield to 1.89% and the 10-year yield to 2.09%. The Fed is gathering with Fed Funds futures pricing in at least two rate cuts by the end of 2019 and at least three within the next twelve months.
Facebook Faces Backlash After Announcing Cryptocurrency Project Libra: Facebook announced plans yesterday to get into the crypto-currency space through Project Libra. The announcement has sparked concerns from traditional banking institutions that they could lose further ground to the less- or un-regulated fintech and crypto adventures. According to the American Banker, Facebook is “jumping into cryptocurrency because it’s one of the few areas where regulators are relatively scarce. But that may not be the case for long. … Indeed, Facebook diving in may accelerate action by regulators. … The leaders of both the GOP and Democratic wings of the House Financial Services Committee called Tuesday for Facebook to testify on its crypto plans.” House Financial Services Chairwoman Maxine Waters issued a press release saying, “Given the company’s troubled past, I am requesting that Facebook agree to a moratorium on any movement forward on developing a cryptocurrency until Congress and regulators have the opportunity to examine these issues and take action.”