There’s a saying attributed to Mark Twain regarding weather in New England, though it's been used in virtually every state, to the effect that if you don’t like the weather, wait a few minutes and it will change.
Investors may feel the same way about the economic outlook, as prospects for a U.S.-China trade accord fluctuate and economic indicators seem mixed. Hiring is strong, business investment is weak. The stock market is hitting new records when there is optimism on trade talks and slipping when the optimism fades.
Analysts worried that the minutes of the Fed’s policymaking meeting in October—released Wednesday after the standard three week delay—would be stale because a certain easing bias in the official statement then has been overtaken by more bullish news.
But that happy state of affairs existed before the latest reports of an impasse in the trade talks. The concerns expressed three weeks ago now seem timely once again.
Considerable Dithering, Elevated Economic Downside Risks
The minutes, in fact, show considerable dithering. Things were going not so well in the first weeks after the previous meeting in September, then seemed to be going better in the latter half of the period as a trade accord loomed large and Brexit appeared to be moving to resolution. Nonetheless, some of the economic sluggishness abroad threatened to spill over into the U.S.
The trade talks have suffered a severe reversal and we really don’t know how any of this is going to turn out. Optimists see the glass half full despite all the uncertainties while pessimists see that half-empty glass draining completely.
There is a school of thought that gloom and doom is overdone, that growth in Europe and emerging markets will rebound, that the U.S. will slow down but not too much. In this scenario, the Fed would probably not take any action at all in 2020.
Market participants nonetheless are seeing a 50-50 chance of a further reduction in interest rates by June, according to CME trading in Fed funds futures.
The October minutes show Fed staff in the glass half-empty category, revising growth forecasts downward and judging the risks to growth tilted further to the downside. They were pessimistic in thinking that trade tensions and a slowdown of global growth would have a negative impact on the U.S. economy, something that couldn't be easily resolved via policy. Staff also saw little hope of a pickup in inflation.
Policymakers largely agreed with this assessment and viewed the downside risks to the economy as “elevated.” All this encouraged them to think that a further quarter-point cut in October would be a good idea. There was some dissent, with hawks arguing that the impact of previous cuts had not yet come through and further accommodation might spur excessive risk-taking.
The committee decided that data would have to prompt a “material reassessment” of the economic outlook for the Fed to take any new action on rates after the October cut. This was the phrase that Fed chair Jerome Powell hammered home in the press conference following the October meeting, using it several times not only in his opening statement but in response to questions. He repeated it again in his testimony last week before the Joint Economic Committee in Congress regarding what it would take for the Fed to act again.
Does all this add up to an easing bias? New York Fed chief John Williams provided a clue this week when he said that risks to the economy are still tilted downwards. A downturn in the economy or a sustained move of inflation in “the wrong direction” could make a case for further accommodation.
Meanwhile, the odds of a rate cut by July are shortening in futures trading. The Fed’s concerns three weeks ago seem once again quite pertinent and not at all stale.