As expected, the Fed lowered rates by 25 bps and indicated that it would be ending its balance sheet reduction a few months earlier than anticipated. Notably, two Fed members dissented preferring to keep rates where they were. But, after a virtuoso performance in June, Chairman Powell fumbled the ball during the presser and the markets reacted negatively. Speaking in earnings conference call terms, someone suggested that he met consensus, but blew the guidance – an apt analogy in our estimation. Admittedly, he had a very difficult needle to thread. Nonetheless, we believe the rationale was weak and the explanation was shallow – frankly, you would have thought he would have been better prepared. In our opinion, being all over the place didn’t inspire confidence at a time when the market craved a simple, straightforward explanation to a rate cut that was “data independent” (we will aside for now whether or not the market deserved it). At one point during the day, the S&P 500 was down almost 1.8%.
Markets were initially up (albeit modestly) on rate cut announcement. Then Powell spoke. The first thing that set markets off was when he characterized the rate cut as a “mid-cycle adjustment” as part of a natural continuation of the Fed’s earlier pivot – interpreted by the market as “one and done.” Shortly thereafter, when questioned, he walked that back saying he meant there would be no “long-term” rate cutting cycle, but not necessarily just one rate cut – in essence, preserving the option to go again, or several times as part of this new “mid-cycle” approach. And the market recovered a bit.
At some point later, in response to a question as to whether a 25 bps cut even mattered, he suggested the Fed could raise rates from here – just likely not right now.
In response to another question, he pointed to several culprits – trade wars, the global slowdown and persistently stubborn below-target inflation. In short, we think part of this discussion was just plain scary. Especially when he suggested that trade tensions seem to be having a significant impact on financial conditions and economic activity. Yet there was very little precedent for how to address trade wars with monetary policy – in effect the Fed was “learning by doing” with respect to this risk. And the discussion about economic activity ranged from troubling (especially when discussing Europe and Asia) to a hint that all stable in the US but could be heading in the wrong direction.
Brutal honesty, but not full disclosure. In our opinion, this was mostly about correcting the mistake they made in December 2018 and desperately trying to avoid becoming Japan, where inflation expectations have become anchored to a much lower inflation level than the 2% target purported by the Bank of Japan (BOJ). Having lost that credibility, the Japanese economy has suffered with stagflation for almost 20 years and the BOJ has been powerless to stop it. With Europe possibly heading in that direction (maybe irretrievably), the Fed wants to steer well clear of this path. Understandably.
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