The Fed Shifts

A Federal Reserve (Fed) rate cut is now officially on the table.

As shown in the LPL Chart of the Day, Fed Dots Reflect Lower Rates in 2019,” updated rate projections show eight of the 17 Fed members expect at least one rate cut by the end of 2019.

The Fed chose to keep rates unchanged for now, but policymakers prepared investors in a measured fashion for an eventual policy shift. The Fed dropped its “patient” policy stance in the post-meeting press conference and instead reiterated Fed Chair Jerome Powell’s June 4 comments that policymakers will “act as appropriate to sustain the expansion.”

That doesn’t mean a July rate cut is a certainty, even though financial markets now think that’s the case. Powell emphasized a U.S. economy that is performing “reasonably well” with solid economic fundamentals and noted that many sectors are still healthy. The Fed kept its gross domestic product (GDP) growth projection unchanged at 2.1% for the year, in line with average output growth in this expansion.

Powell added, though, that global “cross currents” have re-emerged. Policymakers also reduced their projection for core personal consumption expenditures (PCE) growth in 2019 to slightly below the 2% target. Inflation is now looking less transitory in policymakers’ eyes, and that could be enough to justify a rate cut in itself (as stable inflation is one half of the Fed’s dual mandate).

“The latest growth and inflation data, along with U.S.-China trade tensions, provide cover for the Fed to lower rates,” said LPL Research Chief Investment Strategist John Lynch. “We don’t believe that current economic conditions alone justify a rate cut, but Fed policy is too tight for a prolonged trade war.”

Powell noted that policymakers need to see more risks to the economic outlook before changing policy, another hat tip to the Fed’s new watchful (but not overpromising) stance. Powell remained especially coy about the U.S.-China trade dispute’s impact on policy—a smart move in our eyes, as the trade situation is volatile, and the Fed prides itself on being data-dependent. The G-20 Summit also takes place next week, and the United States and China have agreed to meet there about trade.

The Fed’s new cautious stance has been enough to soothe markets, but policymakers’ hands are now tied to looser policy if conditions don’t markedly improve. We think a rate cut in July is a strong possibility, especially now that the Fed has prepared investors for it.

Economic reports over the next month will be telling. So far, though, we don’t see evidence of a near-term recession, and we expect any rate cut to be nothing more than a course correction.


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