Fed split deepens - Capital Economics
US Economics

Fed split deepens

US Economics Update
Written by Paul Ashworth

The Fed voted to cut its key policy interest rate by an additional 25bp today, to between 1.75% and 2.00%, but the FOMC is more split than ever over what to do next.

  • The Fed voted to cut its key policy interest rate by an additional 25bp today, to between 1.75% and 2.00%, but the FOMC is more split than ever over what to do next.
  • Close to one-third of the FOMC is projecting another rate cut before year-end, while close to another third disagreed with today’s rate cut (and may even believe that cut needs to be reversed again within the next three months). The remaining FOMC participants expect no change. Further illustrating that split, two officials – Esther George and Eric Rosengren – voted for no change today while another – James Bullard – voted for a 50bp cut.
  • The statement was largely unchanged from July and, along with the new economic projections that were also almost completely unchanged, it suggests most Fed officials still see a rebound in economic growth as their base case scenario, which means any further rate cuts would be limited. This could still be characterised as a mid-cycle adjustment rather than a full-blown loosening cycle. The only addition to the statement is that exports are now explicitly identified as a source of weakness. As it was in July, today’s cut was justified on the basis of “the implications of global developments for the economic outlook as well as muted inflation pressures”.
  • The dot plots are where things got crazy. Seven officials project another 25bp cut before year-end, but no further cuts in 2020 to 2022. At the same time, five officials see the fed funds rate going back to between 2.00% and 2.25% by year-end (or at least disagreed with today’s cut.) Under those circumstances of such a big split, the median rate projections are essentially useless.
  • The Fed made some minor changes to try and alleviate the liquidity problems that sent money market rates soaring in recent days, but there was no hint of a return to quantitative easing or the introduction of regular scheduled repo auctions. (See Chart 1.) In short, the Fed cut the interest on excess reserves (IOER) rate by 30bp, so that at 1.8% it now sits only 5bp above the floor of the fed funds target range. As recently as June last year, the IOER rate was in line with the ceiling of the fed funds target range. Similarly, the offer rate on the reverse repo facility was cut by 30bp to 1.7%, presumably to make the facility less attractive so it doesn’t soak up as much liquidity.
  • Nevertheless, in his press conference Chair Jerome Powell did acknowledge that the Fed could, if needed, introduce more regular repo auctions and that the FOMC would examine whether it needs to resume the “organic growth” of the balance sheet “sooner than we thought”, which would means the permanent addition of more Treasury securities. But the Fed would presumably only purchase Treasury securities on an ad hoc basis rather than launching a QE4-style program that ran over a more extended period.
  • Overall, we still expect the Fed to cut the fed funds rate once more in December – to between 1.50% and 1.75% – which is broadly in line with fed funds futures rate expectations. (See Chart 2.) Unlike the futures market, however, we don’t expect the Fed to continue cutting interest rates next year.

Chart 1: Selected Interest Rates (%)

Chart 2: Fed Funds Futures Rate Expectations (%)

Sources: Refinitiv, Bloomberg