The US economy is “in a good place,” Fed officials say: Unemployment remains at a half-century low, with little pressure on inflation. And yet after the Fed slashed its benchmark policy rate in July and in September, investors expect another cut this week.
Fed officials have described the cuts as an insurance premium, to prevent a global slowdown in trade and manufacturing from dragging on American consumers.
Here’s what to look for when the Fed’s Open Market Committee concludes discussion of its policy rates on Wednesday:
Has the insurance premium been paid?
Traders have priced in a 95 per cent likelihood of another 25 basis point cut this week, according to an analysis of bets on the Fed’s policy rate by the CME Group. Fed policymakers have said little that would discourage them. That would make 75 basis points of easing since July.
Michelle Meyer, chief US economist for Bank of America Merrill Lynch, said that’s the norm for insurance cuts, and will be watching for language from chair Jay Powell’s press conference on whether insurance is still the right metaphor.
“Now that they’ve delivered their insurance cuts,” said Ms Meyer, “what are they looking for in the real-time data?”
Tim Duy, professor at the University of Oregon said the Fed may be done fending off the trade war, and is going to have to lay out what the conditions are for any further action. “A lot of things seem to be going right,” he said, “It just doesn’t look to me like there’s any strong evidence that there’s anything falling off a cliff.”
Markets have come round to the idea the Fed could pause after this week’s cut to have another look. According to the CME Group, investors are pricing in just a one-in-five chance of another quarter-point reduction in the benchmark policy rate in December.
A new adjective for consumer spending
The US Department of Commerce will release its first read on third-quarter growth on Wednesday morning, hours before the Fed releases its decision. Jim O’Sullivan, chief economist at High Frequency Economics, said that growth data would probably show consumer spending had slowed.
If it does, he said, the Fed may change its adjective for consumer spending, from “strong” to merely “solid”.
It’s a small change that could make a big difference. This adjective, paired with how chairman Jay Powell expands on consumer spending in his Wednesday press conference, will show how worried the Fed is about the main engine of US growth, and offer a clue for December’s meeting.
Just how bad are the data on business investment?
The GDP data will show whether US businesses, uncertain of the path of the trade war, continued to hold off on making decisions on new plants and equipment. Growth in business investment collapsed this year, and even contracted in the second quarter.
Gregory Daco, chief US economist at Oxford Economics, said it would probably shrink again in the third quarter. “That would be actually the first back-to-back contraction since the last recession,” he said. The Fed takes this number seriously; a paper by economists at the Fed’s Board of Governors in September showed how uncertainty can drag on business investment and, eventually, economic growth.
“If [business investment] is substantially more negative, you’re into the world where you’re looking at another rate cut in December,” said Mr Duy.
Inventories — goods that companies have purchased, but not sold to customers — are “a bit of a wild card”, according to Ms Meyers. If the commerce department’s data on Wednesday morning show that inventories are high, then businesses are sitting on stock they can’t sell, and Mr Powell may have to address it in his remarks on Wednesday afternoon.
Is the Fed prepared to handle year-end funding pressures?
After a cash crunch sent short-term borrowing rates as high as 10 per cent in September, the New York Fed stepped into the market for repurchases or “repo”, where banks and investors borrow cash overnight.
In the weeks since, it has repeatedly increased the size of its overnight operations. Just last week, it said it would once again raise the limit on the amount of cash it would lend to the market to at least $120bn daily.
The Fed has also resumed purchases of short-term US Treasury bonds to expand its balance sheet and increase the amount of reserves in the system. Some strategists have warned that this $60bn a month in purchases, along with repo operations, may not be sufficient to avoid funding pressures bubbling up at year end, when the demand for cash typically rises as banks step back from lending to the market ahead of important regulatory deadlines.
Expect Mr Powell to come prepared with a plan to keep enough cash in the markets at the end of December. And expect him to say, again, that the Fed’s interventions are about market plumbing, and not monetary policy.
