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Economic Insights

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. 

 

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