Will the Fed cut rates in 2019?
By Blu Putnam, CME Group
Published: 14 June 2019
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
CME Group’s Fed Watch tool shows a strong probability of two rate cuts by the Federal Reserve (Fed) in 2019. Many analysts agree with the indications from the federal funds futures market, but they have concerns. Will the trade war weaken the U.S. economy? Is the flat yield curve signaling a recession is coming in 2020? Will there be a debt ceiling or government shutdown crisis in the fall of 2019? These are real risks, and the futures market reflects these concerns. Nevertheless, it is worth noting that futures markets provide a view into the current consensus expectations of market participants, but expectations have a way of changing over time as new information becomes available.
Here we take a different approach based on the observation that the Fed is data dependent, with the implication that the Fed does not try to anticipate economic data. Thus, instead of providing reasons why the Fed might cut rates in 2019, we work through the Federal Open Market Committee (FOMC) policy meetings in 2019 and provide our analysis of why the Fed might cut rates or stand pat based on an analysis of only the historical data they will be examining as they meet. Our conclusion is that if lower rates are coming, the Fed may cut rates sooner rather than later.
June 19, and July 31, 2019 FOMC Meetings
The June FOMC meeting occurs against a backdrop of trade war worries and slowing job creation. The problem is new jobs are not being created as fast as in 2018, but layoffs are minimal as reflected unemployment holding at 3.6%. When the FOMC meets on July 30-31, it will have received a few days earlier (July 26) the Bureau of Economic Analysis (BEA) advance report on Q2/2019 GDP. It will also have seen data on the employment situation for June (released on July 5) by the Bureau of Labor Statistics. And, it will have in its possession a variety of metrics on inflation and hourly wages for the month of June. Job creation is a question mark. The unemployment rate is likely to still have a reading at or below 4%. Q2 Real GDP may turn out to be a little lower than the 3.3% posted for Q1/2019. Inflation, or the lack of it, will probably be a part of the FOMC debates, as in previous meetings. We do not see the core inflation rate or sluggish wage growth being sufficiently weak as to prompt a rate cut, at least not yet. All in all, there are no signs suggesting the data is likely to be weak enough to stir a sudden desire in the FOMC to cut rates.
If the Fed decides to cut rates in the summer of 2019, the Fed will have to break with precedent and do so based on the forecast that in the second half of 2019 the trade war will result in weak job growth, rising unemployment and sluggish real GDP growth. This will be a very tough decision for the Fed to get into the forecasting business because of a trade war about which they may have decidedly mixed feelings.
There is a second consideration for the Fed. Will the rate cuts make any difference to the economy? If the main reason that jobs are not being created is corporate worries about the weaponization of tariffs and retaliation from impacted countries, then it may not matter if the federal funds rate is 2.4%, 1%, or even zero. Businesses worried about the trade war are not going to expand jobs while their supply chains are being disrupted and global demand is falling. So, if the Fed does cut, it will have to break precedent, base its case on forecasts, and yet appreciate that the rate cuts may not help.
September 18, 2019 FOMC Meeting
More than likely in September, President Trump and Congress may be fighting over the debt ceiling and funding the Government. The debt ceiling stands at $22,028,945,980,301.65 or just over $22 trillion. The U.S. Treasury has been managing its cash carefully to stay under the ceiling. With annual trillion-dollar budget deficits occurring as a direct result of the December 2017 corporate tax cuts, time will run out on the U.S. Treasury’s ability to stay under the debt ceiling around September 2019, give or take a few weeks either way. And there is also a government funding crisis brewing. Authorized U.S. Federal Government funding will end on September 30, 2019, unless the U.S. Congress and the President can agree on new funding for Fiscal Year 2020.
The Fed will have absolutely no desire to step into the debt ceiling and funding political debate. If the Fed had decided to cut rates in the summer, the Fed is unlikely to cut again. If the Fed remained on hold in the summer, the data-dependent Fed may just stay on hold and see whether there is a compromise or whether the federal government shuts down again, as it did for 35 days in December 2018 through late January 2019, and also whether a debt ceiling crisis causes any missed coupons or redemptions that could put US Treasury securities into a technical default.
October 30, 2019 FOMC Meeting
There are two scenarios of what the Fed will be debating at its meeting just before Halloween, and possibly the day before the UK crashes out of the European Union with a nasty, hard Brexit. Of course, the Fed does not care about Brexit for making U.S. interest rate policy, it is just an interesting aside occurring at the same time as the FOMC meets.
So back to the two scenarios. One, the federal government is shut down and there is a full-blown debt ceiling crisis, which means the Fed will do absolutely nothing until after the crisis has been resolved, the government re-opened, and a full quarter of GDP data available to assess the economic damage. Or two, a compromise was reached between the Democratic-controlled House of Representatives, the Republican-controlled U.S. Senate, and President Trump. With the debt ceiling raised and the government funded for fiscal year 2020, the Fed will sigh with relief, express optimism about the economy, expect inflation to creep higher in 2020, and so the Fed will do nothing.
December 11, 2019 FOMC Meeting
In December, the Fed will be waiting on Q4 real GDP and inflation data before making any decision on cutting rates. Remember, this is now the longest U.S. economic expansion on record, and economic expansions do not die from old age, they typically end due to policy mistakes. Doing nothing and letting the economy continue to grow, albeit modestly, with subdued inflation below the Fed’s 2% target is the likely course of action. The available data are unlikely to convince the few remaining “hawks” on the FOMC who are still worried about future inflation to switch to a “dovish” vote. Most FOMC members will occupy the undecided middle ground, because the economic data is conveniently mixed and unlikely to make a convincing case.
Bottom Line
- The Fed prefers to be data dependent.
- It will be a tough call for a data-dependent Fed to anticipate economic weakness from the trade war and take pre-emptive action that it knows may be ineffective.
- If a data-dependent Fed does break precedent and cut rates over trade war fears and forecasts of coming economic weakness, the Fed is more likely to act in the summer of 2019 rather than later in the year when debt ceiling and government shutdown debates kicks into gear.
- Consequently, if the Fed cuts rates, it may be sooner rather than later. But, there will be some FOMC members who will be uncomfortable with a pre-emptive rate cut based on uncertain forecasts of the trade war’s impact on job creation.