The Fed Will Likely Cut Rates This Week - But Why?

The US unemployment rate is 3.7%, inflation is on the rise, and Fed Chairman Jay Powell clearly stated at the July FOMC meeting that the Committee did not intend to cut rates again anytime soon. So why are markets pricing in overwhelming odds of a rate cut at this week’s FOMC meeting?

Here are five contributing factors:

  1. Volatile Financial Markets: Late cycle volatility and last month’s steep stock market selloff have shaped the narrative that US policymakers are poised to cut rates for a second consecutive meeting.

  2. Soft Domestic Data: Although the Fed is mandated to focus on inflation and employment (currently two of the strongest data points in the US economy), underlying manufacturing and consumer data has weakened substantially in recent months.

  3. Trade Tensions: Despite what currently seems to be a bright moment in the rocky US-China trade negotiations, the ongoing tensions are likely to continue to drag on both economies until/unless a comprehensive trade agreement is put in place.

  4. International Monetary Easing: Up until the last few weeks, the only substantial easing moves this year had come from APAC central banks (the Reserve Bank of Australia, Reserve Bank of New Zealand, and People’s Bank of China) that cut rates and/or instituted new stimulus measures. Although this easing was disconcerting for Fed policymakers, it was not a stark call to action in the way that last week’s ECB rate cut and asset purchase plan appears to be. Setting aside the fact that Mario Draghi may have instituted these plans a bit ahead of schedule as a favor to his successor, Christine Lagarde, the message is clear: global central banks are easing.

  5. Politics: Though Fed policymakers will vociferously deny that politics plays a role here, the extremely public pressure President Trump has put on Powell to cut rates cannot be denied. Powell almost certainly does not want to be held responsible for accelerating the path to a recession.

All of this, plus lingering downside risks posed by Brexit, explain why Fed sentiment has fallen more than half of a standard deviation (as measured by Prattle scores) since the July FOMC meeting. This fall in sentiment suggests Fed policymakers are likely to cut rates this week. When coupled with growing international pressure in the form of expected stimulus measures from the Bank of Japan and Swiss National Bank this week, a 25bps rate cut from the Fed appears to be a near certainty.

 

By Evan Schnidman, CEO of Prattle, a Liquidnet Company

Harrison Short