FOMC Post-Mortem

The Fed delivered another dovish surprise. Whilst the Fed did not pre-commit to a rate cut in July, markets are certainly taking it that way. We are maintaining our broad macro calls for now but acknowledge that excessive Fed dovishness will surely keep testing us.

RECENT DEVELOPMENTS

As expected, the Fed left rates steady. What was unexpected was that eight FOMC members now see rate cuts this year as appropriate vs. none in March. That number rises to nine in 2020. The end-2019 median Fed Funds remains at 2.375%, but the end-2020 median dropped to 2.125% from 2.6125% in March. Lastly, the median longer run Fed Funds rate is now at 2.5% vs. 2.75% in March.

The Fed tweaked its economic forecasts. The median GDP growth forecast for 2019 was kept steady at 2.1% but the median forecast for next year rose to 2.0% vs. 1.9% in March. Unemployment forecasts were cut a tick for this year and next to 3.6% and 3.7%, respectively. Lastly, core PCE forecasts were cut for this year and next to 1.8% and 1.9%, respectively, from 2.0% for both previously.

The statement language was different as the Fed dropped its “patient” approach. Instead, the Fed pledged to “act as appropriate to sustain the expansion.” We also got the first dissent under the Powell regime, with one FOMC member calling for a rate cut. Markets took all these developments as a pre-commitment to cut rates in July. We disagree and continue to believe that the decision remains data-dependent.

After the FOMC decision, implied yields across the Fed Funds futures strip fell. The January 2020 contract is now at 1.62%, which is fully pricing in three cuts this year. The January 2021 contract is now at 1.29%, which is fully pricing in one cut next year and part of a second. This seems way too aggressive to us. These are not insurance cuts, these are recession cuts.

Yet with strong May retail sales and significant upward revisions to April, Q2 is now looking pretty good. Atlanta Fed GDPNow has Q2 growth at 2.0% SAAR, down from 2.1% previously. NY Fed Nowcast has Q2 growth at 1.4% SAAR vs. 1.0% previously. It also raised its Q3 reading to 1.7% SAAR from 1.3% previously. While a slowdown from Q1 (3.1% SAAR) was to be expected, markets will be particularly sensitive for signs of a larger than expected drop-off.

 

INVESTMENT OUTLOOK

We continue to believe the Fed’s ongoing dovish shift is positive for US equities. That, coupled with what we view as underlying strength in the US economy, should keep US equities moving higher. Of course, this remains subject to developments on the global front, especially with regards to the ongoing trade tensions with China and other major US trading partners.

We remain bullish on the dollar due to our underlying optimism regarding the US economy. Interest rate differentials and monetary policy divergences still favor the dollar, at least for now. Again, we stress that Fed rate cuts should not be viewed as a done deal. It is data-dependent. Yet despite the market’s uber-dovish take on the Fed, the dollar has held up well so far.

What’s also driving our ongoing dollar bullishness is that as dovish as the Fed has shifted, other major central banks have also shifted in the same manner, if not more so. The ECB added stimulus at its March meeting by announcing a new TLTRO and now appears to be teeing up a rate cut before year-end, while BOJ Governor Kuroda has signaled he is ready to add stimulus as needed. We should get more clarity on this after tonight’s BOJ meeting. BOE meets tomorrow and is going nowhere fast. RBA and RBNZ are already cutting rates, while market sees the BOC joining them by year-end.

We have long felt that the game-changer for the dollar would be the next US recession. The Fed would cut rates aggressively even as the fiscal deficits blew out. Interest rate differentials would no longer be moving in the dollar’s favor, while ballooning deficits and debt issuance would make it harder and harder to attract the necessary capital to finance those deficits. However, we are clearly not there yet.

The next major US data releases won’t be seen until the week of July 1. June ISM manufacturing PMI will be reported Monday July 1. ADP private sector jobs will be reported Wednesday July 3 ahead of the June jobs report Friday July 5. June CPI and PPI data will be reported the week of July 8, while the Fed releases FOMC minutes Wednesday July 10. Each of these data points have taken on more significance given the Fed’s shift to more data-dependence, in our view.