Fed Cuts Rates: What Comes Next?

Not surprisingly, the Fed cut rates by 25 basis points at yesterday’s meeting. With the cut, the Fed Funds rate sits at 4.00-4.25%. While the market was nearly certain of a 25bps cut, it is less clear about what the road ahead holds for Fed policy. To help us start thinking about how policy may change at the upcoming meetings, we share a few comments from yesterday’s FOMC meeting.

• The Fed economic projections, shown below, quantify the changes in the forecasts of FOMC members over the last three months. Their expectation for real GDP increased from 1.4% to 1.6%. Despite recent weakness in employment data and an uptick in CPI, their forecasts for unemployment and PCE inflation are unchanged. Its Fed Funds projections fell from 3.9% to 3.6%, reflecting the 25bps rate cut.
• Every member voted for a 25-basis-point cut, except the newest member, Stephen Miran. He dissented and voted for 50 bps. Based on the dot plots, he believes Fed Funds should be 2.875% by year-end.
• The FOMC statement alludes to recent weakness in the labor markets but notes that “inflation has moved up and remains somewhat elevated.” They claim that “downside risks to employment have risen,” which explains why they all voted to cut rates.

“Since April, the risks of higher and more persistent inflation have become a little less.” Powell’s less troubling inflation outlook, coupled with worsening employment data, makes him more comfortable cutting rates.

• Powell anticipates that increases in goods prices will be “one-time” in nature, but will closely follow. “The case for a persistent outbreak in inflation is less.”
• He noted on numerous occasions the unique tension between its employment and inflation mandates and how it complicates its forecasts for the Fed Funds rate.
• Powell deems Fed policy is “more moderate” but still restrictive.
• The Fed was expecting the employment revisions, but is concerned about the low response rates in the BLS survey.
• The Fed believes that the company’s importing goods are largely paying tariffs, not consumers or the exporting countries.

“It’s not obvious what we need to do.” Based on that comment and other similar comments, the Fed is not confident in answering our question of what comes next.

BBB and AA Corporate Spreads Show Investors Have Extreme Confidence

At first glance, the red-highlighted corporate spreads, reading 0.00% appear to be an error. It’s not! Corporate bond yield spreads versus US Treasury yields for BBB and A-rated bonds are at their tightest levels in the last 20 years. In other words, corporate bond investors are willing to accept a record-low premium to assume default risk.

The data below makes it clear that corporate bond investors are largely unconcerned about an economic slowdown or recession, which could lead to downgrades and defaults. Corporate bond yield spreads parallel equity sentiment. While corporate spreads are incredibly tight, the stock market is at an all-time high. Both markets seem to be ignoring weakening economic data. Clearly, both the bond and stock markets indicate that investors are highly confident that Fed rate cuts will stave off a recession, should one occur.

Job Security Worries Should Worry The Fed

The latest University of Michigan Consumer Sentiment survey sits near 50-year lows. Surprisingly, it’s below the trough reached during the 2008 financial crisis and just above the pandemic lows. The Conference Board’s Consumer Confidence Index is not as dire, but it too is not far from the Pandemic lows.

While political affiliations are certainly influencing the results more than usual, we must still acknowledge that low confidence, regardless of the reason, negatively affects personal consumption. Moreover, personal consumption accounts for about two-thirds of GDP.

Today, we focus on confidence in one’s employment as it is probably the most critical subcomponent of confidence in relation to consumption. The first graph below shows that the percentage of people expecting higher unemployment in a year is near a 30-year high. Similarly, those expecting to lose their job in the next five years are also very high.

In the second graph, we compare the percentage of those expecting to lose their job with retail sales. As we highlight, following each peak, retail sales trend downward. Given that the current level of retail sales is decently lower than the prior peaks, a similar downtrend could push retail sales negative, something that typically coincides with a recession.

Tweet of the Day

Original Post