The Market Today
Markets Imply Fed May Be Behind the Curve Despite Dovish FOMC Result
by Craig Dismuke, Dudley Carter
Jobless Claims Say Labor Market Remains Resilient: Initial jobless claims for the week ending June 15 fell 6k to 216k, back toward the low side of the recent 210k-230k range. The four-week moving average rose to 219k but shows a generally lower trend after a December-through-February spike.
Another Regional Fed Report Portends Weak Business Investment: The Philadelphia Fed’s Business outlook index fell from 16.6 to 0.3, joining the previously-released Empire Fed report in disappointing expectations. The sub-indices covering new orders, number of employees, and the average workweek all fell. Combined with the Empire Fed index, the regional reports point to a further decline in core capital goods orders, and subsequently business investment.
Leading Index: At 9:00 a.m. CT, the Leading Index for May is expected to rise 0.1% but weaken from April’s 0.2% gain. Despite the report being called the Leading Index, most of the data points are already known and the report is unlikely to move the markets.
Yesterday’s Trading – Markets Rally as Investors Feared Fed Behind the Curve: Markets seemed to be underwhelmed by the Fed’s policy decision, perhaps disappointed that they did not move forward with a rate cut. As a result, markets immediately priced in even more future easing than previously expected. Prior to the decision, futures implied a 100% chance of a 25 bps cut in July and no chance of a 50 bps cut in July. They implied two 25 bps cuts by year-end along with a 32% chance for a third cut. After the decision, futures implied a 100% chance of a 25 bps cut in July and a 32% chance of a 50 bps cut in July. By year-end, futures implied an 84% likelihood of a third 25 bps cut. While the markets may have overdone the response, the expectation that the Fed was falling behind the curve was evident. The expectation for even easier monetary policy spread through other asset classes. The S&P 500 rose 0.4% after the announcement and gold rallied 1.0%. Treasury prices rose across the curve sending the 2-year yield down 14 bps to 1.74% and the 10-year yield down 6 bps to 2.03%, both the lowest closing yields since 2016. The Dollar, however, fell 0.3% before recouping half that loss into the close.
Overnight Trading – Investors Believe the Punch Bowl Is Being Dusted Off: Global markets responded to the Fed’s decision immediately overnight with the 10-year Treasury yield plunging below 2.00% as Asian trading opened. The yield fell as low at 1.97% and is coming into U.S. trading back up at 2.01%. The 2-year Treasury, which fell 14 basis points immediately after the Fed decision, held at the new, lower level trading near 1.72% overnight. These remain the lowest yields Treasurys have seen since the 2016 election. The rally has pushed other sovereign yields, globally, lower as well, exemplified by the German 10-year dropping 2.4 bps to -0.32%. Asian stocks rallied led by a 3.0% increase for Chinese stocks, a 1.2% gain for the Hang Seng, and a 0.6% gain for the Nikkei. Eurozone stocks are up 0.8%. Dow futures have joined the equity rally, up 280 points (1.1%) overnight from yesterday’s close.
FOMC Cites Weakness, Tees Up Possible Future Rate Cut: The FOMC tilted decidedly dovish in yesterday’s policy decision, but stopped short of cutting their overnight target rate range. In their Official Statement, officials noted a weaker economic assessment, a weaker outlook for business investment, below-target inflation, and increased uncertainty. Perhaps most importantly, they removed their language saying that the “Committee will be patient as it determines what future adjustments” should be made. This change of language has previously been used as a signal for a policy change at a subsequent meeting. As such, this Statement appears to be setting up a possible July rate cut. St. Louis Bank President James Bullard dissented, preferring to move forward with a rate cut at this meeting.
Officials Expect to Cut Rates in 2019 or 2020: The Summary of Economic Projections painted an even more convincing picture of the Fed’s tilt. While the median projection for rates at YE19 remained unchanged at 2.375% (target range midpoint), eight (out of seventeen) participants believe rates will end the year lower than 2.375%. Moreover, seven participants believe the target range will be 50 basis points lower. Only one official expects the target rate to be increased before year-end. The biggest change, however, was the forecast for rates at the end of next year. The median projection for YE20 50 basis points from 2.625% to 2.125%. In aggregate, Fed officials now believe rates will end 2020 lower than the current target. This marks the first Summary of Economic Projections in which Fed officials have collectively signaled a lower rate expectation in a future year. Longer term, the median expectation for the neutral rate was lowered from 2.75% to 2.50%.
Inflation Projections Lower: Finally, officials now believe inflation will further undershoot their 2.0% target through the end of 2020. Headline PCE inflation is now expected to end 2019 at 1.5% (down from 1.8%) and 2020 at 1.9% (down from 2.0%). At the core level, officials now expect PCE to end 2019 at 1.8% (down from 2.0%) and 2020 at 1.9% (down from 2.0%). Based on the methodology of the SEP, it is correct to deduce that officials now believe inflation will undershoot their target through the end of 2020 even if they cut rates at least once.