US interest rates: Fed cut a “mid-cycle adjustment”
US Federal Reserve meeting

US Federal Reserve decision: As expected, the US Federal Reserve’s Open Market Committee (“FOMC”) reduced the target range for the federal funds rate by 25 basis points (quarter of a per cent) to between 2.00-2.25 per cent – the first rate cut since December 2008. FOMC members voted 8-2 to cut interest rates. Boston Federal Reserve President Eric Rosengren and Kansas City Federal Reserve President Esther George both voted to keep rates unchanged.

US interest rate outlook: In its statement, the FOMC stated that as “the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook.” US Federal Reserve Chair Jerome Powell later cautioned, “It’s not the beginning of a long series of rate cuts”, but added “I didn’t say it’s just one …we’re thinking of it as essentially in the nature of a mid‑cycle adjustment to the policy” at his press conference after the central bank announced its decision.

Changes in US monetary policy settings can affect rates in Australia as well as the sharemarket and currency.

What did the Fed decide and what does it all mean?

• Who’d be a central banker? Interest rate cuts normally boost sharemarket sentiment. But financial markets reacted negatively after the US Federal Reserve cut interest rates for the first time since December 2008. US shares fell sharply, shorter-dated US Treasury bond yields lifted and the US dollar hit two-year highs. The Aussie dollar bore the brunt of whipsawing markets, falling from highs of near US68.98 cents to lows near US68.32 cents and was near US68.48 cents in late US trade.

• Why? In his press conference Fed Chair Jerome Powell was more “hawkish” than expected, wrong-footing traders who were hoping for a more “dovish” cut (i.e. more explicit confirmation of further policy easing). In fact, Chair Powell called the rate cut a “mid-cycle adjustment”, adding “it’s not the beginning of a long series of rate cuts”, implying that the central bank was not embarking on a lengthy rate-cutting cycle, as in a recession, dampening future interest rate cut expectations.

• In its statement, the FOMC cautioned that “In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2¼ percent.”

• Along with the rate cut, the Committee decided to end the reduction of bonds it is holding on its balance sheet. The Fed’s balance sheet will stop being reduced effective from August 1 with assets totalling around US$3.6 trillion.
What are the implications of today’s decision?

• In his press conference, Chair Powell said that “the committee still sees a favourable baseline [economic] outlook”, but the rate cut was focused on “insuring” against downside risks, such as the re-intensification of US-China trade tensions, which have “returned to simmer.”

• Slower global growth, moderating factory activity, muted inflation, fading fiscal stimulus (i.e. tax cuts) and slowing business investment have all been cited as risks to the continuing US economic expansion.

• While some traders were holding out for an even larger 50 basis point rate cut by the FOMC, recent US economic data releases have been more positive, supporting the Fed’s data-dependent stance.

• While annualised US economic (GDP) growth was a more “moderate” 2.1 per cent in the June quarter, labour market conditions remain “strong” with the July unemployment rate forecast to fall back to 49-year lows of 3.6 per cent when released on Friday. And the Conference Board’s consumer confidence index lifted to the highest level this year in July, pointing to a potential lift in growth in the September quarter on the back of solid spending.

• Following the release of the FOMC statement, US shares fell sharply. The Dow Jones declined as much as 478 points during trading, closing lower by 333 points or 1.2 per cent. The S&P500 was down by 1.1 per cent and the Nasdaq lost 98 points or 1.2 per cent. A positive earnings result from Apple (up 2 per cent) was overwhelmed.

• The US Treasury yield curve flattened during trading with 2-year yields up as much as 15 points. But US 10-year yields fell by 6 points to near 2.00 per cent. And US 2-year yields rose by just 2 points to near 1.87 per cent.

• The US dollar (USD) has strengthened to near two-year highs, with the USD Index up 0.6 per cent at 98.68 from a pre‑FOMC low of 98.05.

• Commonwealth Bank Group economists still expect the FOMC to cut interest rates in September to support the continued US economic expansion and to coax inflation closer to its 2 per cent policy target.
Comparing the two most recent statements

• The statement from the June 2019 meeting is on the left; the statement from the July 2019 meeting is on the right. Emphasis has been added to highlight key points in the wording in the statements.

Published by Ryan Felsman, Senior Economist, CommSec