Economic Insights
The Fed Loses “Patient” but Remains Calm
The removal of one key word from the June 19 statement appears to show the U.S. Federal Reserve is more willing to cut rates should U.S. economic data weaken.
At the conclusion of its June 18–19 meeting, the Federal Open Market Committee (FOMC), the rate-setting arm of the U.S. Federal Reserve (Fed), signaled another dovish turn for U.S. monetary policy. Crucially, when discussing future rate moves, policymakers removed the term “patient” from their post-meeting statement and in its place said that they would “closely monitor” developments. The statement also emphasized that uncertainties had increased in the outlook. (We discussed the increasing dovishness of global central banks in our recent Midyear Outlook roundtable.)
However, the statement did not include an assessment about the balance of risks. Typically ahead of cuts (or hikes), the statement would say that the balance of risks had shifted to the downside (or upside).
In the economic projections at the end of the meeting, the Fed’s forecast for the personal consumption expenditure (PCE) price index, its favored inflation gauge, was lowered from 1.8% to 1.5% in 2019 and core PCE was downgraded to 1.8% from 2%. This is significant, as the Fed is now expecting that inflation will be below their 2% target this year, providing justification for a cut. (Read my colleague Hyun Lee’s analysis of how the Fed may change its approach to targeting inflation.)
In its now-famous “dot plot” projection, the committee was clearly divided on the rate outlook for the remainder of this year, with seven members forecasting 50 basis points (bps) in cuts, one seeing a single 25 bps cut, eight indicating expectations that rates will stay unchanged. One FOMC hand actually projected a 25 bps hike.
In our view, the dot plot indicates that those members who are expecting cuts this year do not expect further cuts next year. This likely means that the committee is not seeing a recession on the horizon, and that those members who do feel the need to cut see a rate reduction as more of an insurance policy to keep U.S. growth on track rather than a significant downgrade to the economic outlook.
Fed funds futures data from Bloomberg as of June 19 showed that the market is fully pricing in a 25 bps cut at the next FOMC meeting in July and this probability has even increased after the statement. Even though the Fed’s communiqué and the dot plot do not indicate that a cut is imminent, the markets are taking comfort that a lower fed funds rate target seems to be on the horizon.
The yield on the two-year U.S. Treasury note dropped 9 basis points on June 19 following the 2:00 pm ET announcement by the FOMC, and the broad dollar index (DXY), which tracks the value of the U.S. dollar against a basket of other major currencies, fell 30 basis points. Meanwhile, U.S. equities, as represented by the S&P 500® Index, were little changed. (All yield and index data from Bloomberg.)
Summing Up: The Fed Stands Ready
In our view, the Fed still needs to see further weakening in key U.S. economic data, or a collapse in trade talks with China at the upcoming G20 meeting, to cut rates in July. But the central bank is clearly ready to make such a move if the data warrants. What does this mean for investors? We think the Fed’s willingness to loosen policy at the first meaningful sign of weakness—amid continued solid U.S. economic growth—is a supportive factor for risk assets.
The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. U.S. Treasuries are debt obligations issued and backed by the full faith and credit of the U.S. government. Income from Treasury securities is exempt from state and local taxes. Although Treasuries are considered to have low credit risk, they are affected by other types of risk—mainly interest rate risk (when interest rates rise, the market value of debt obligations tends to drop) and inflation risk. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.
Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.
Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes.
A basis point is 1/100 of a percentage point.
The Federal Funds Rate (fed funds rate) is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight.
The Federal Open Market Committee (FOMC), the policy-setting arm of the U.S. Federal Reserve, issues projections of the rate of U.S. economic growth at the conclusion of its meetings in March, June, September, and December of each year.
The personal consumption expenditure (PCE) price index is one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy.
The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.
The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.