September Fed deeply divided



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By Eric Stein, CFACo-Director of Global Income, Eaton Vance Management and Andrew Szczurowski, CFAPortfolio Manager, Global Income Group, Eaton Vance Management

Boston - As expected, the Federal Open Market Committee (FOMC) lowered the federal funds rate 25 basis points (bps) on Wednesday. The market had been pricing in a 50% chance of a 50 bp cut last month, but stronger U.S. economic data and - more importantly - a slight de-escalation of the trade war with China pared back those expectations.

Tweaks to the statement

The statement released at the conclusion of the FOMC's two-day meeting in September had only two minor tweaks from the statement in July. The FOMC upgraded the health of the U.S. consumer to "household spending has been rising at a strong pace" from July's more moderate "picked up." At the same time, September's statement included a downward revision on the business side to "business fixed investment and exports have weakened" from July's description as "soft."

The dichotomy between consumer confidence and business confidence reflects the current state of the U.S. economy in a nutshell. Consumers, the backbone of the U.S. economy, have been incredibly resilient to all that's happening on the trade war front. They remain confident because jobs are plentiful and wages are rising.

Businesses, on the other hand, still face so much uncertainty on the future state of tariffs. Until they have more clarity, it's incredibly difficult for any U.S.-based company to have the confidence to take on a new capital-intensive project.

Cutting rates and moving dots

Though the Fed is well aware that business confidence is not hurting because rates are too high, they decided once again to lower interest rates - pulling one of the few levers they have at their disposal. After all, doing nothing would have spooked the markets, leading to a stronger dollar that could eventually have lowered consumer confidence. In the voting for the policy action, there were three dissents: one policymaker favored a 50 bp cut, while two were against cutting rates at all.

Where the division among the 17 FOMC members really shows up is the so-called dot plot, officially their "assessments of appropriate monetary policy." While the median dot shows not only no more cuts this year but also no cuts next year, there is clearly no consensus on the committee: seven expect one more cut this year, five expect no further cuts and five expect an actual hike!

Powell at the podium

During his press conference after the meeting, Fed chair Jay Powell admitted how divided the monetary policymakers are right now, claiming to see it as "healthy to have diverse perspectives." Following former Fed chair Janet Yellen's practice, he didn't reveal where he stood on the dot plot.

Powell mentioned that the Fed may resume organic balance sheet growth earlier than thought, likely in response to unanticipated pressures in the overnight lending or "repo" markets around large tax payments and U.S. Treasury settlements that came due earlier this week. While such stress might pop up again near quarter or year ends, we believe this is a manageable situation for the Fed. So we could see the balance sheet start to expand in the near future, after shrinking for most of the year.

And taking a page from New England Patriots coach Bill Belichick's playbook that less is more, he continued with the company line that the Fed is data dependent, which we could interpret to mean they are trade dependent. In our view, the main driver of rate cuts this year has been the trade war, which could last another two months, two years or two decades.

Bottom line: Without knowing the future path of the trade war, it's tough to know the future stance of monetary policy. The bond market is pricing in a third rate cut this year and nearly two more cuts next year, evidently in the belief that this isn't just a mid-cycle adjustment. At the moment, we would feel uncomfortable taking additional interest rate risk. We expect to get more clarity on the trade front in the next month, which should set the stage for the future path of the fed funds rate.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.