- Quiet FOMC meeting expected but with an outside chance of an IOER rate cut
- Post-agreement tariffs are a “major obstacle” for US/Chinese trade agreement–WSJ
- ISM manufacturing index expected to show firm confidence
- ADP expected to rebound
Quiet FOMC meeting expected but with an outside chance of an IOER rate cut — The FOMC at its 2-day meeting that concludes today is unanimously expected to retain its neutral policy and leave its funds rate target range unchanged at 2.25-2.50%. Fed Chair Powell will hold a press conference after today’s meeting but the Fed will not release updated macroeconomic forecasts at today’s meeting.
The FOMC at its last meeting on March 19-20 surprised the markets with a dovish outcome as it slashed the Fed-dot forecast and announced that it would end its balance sheet reduction program sooner than expected. Regarding the Fed dots, FOMC members cut their forecast for 2019 to no rate hikes from two rate hikes but left in place their forecast for one rate hike in 2020.
Regarding the balance sheet, the FOMC at its March meeting said it will taper the reduction of its Treasury security portfolio with a new cap of $15 billion starting in May versus its current cap of $30 billion. The Fed said that it plans to fully conclude its balance sheet reduction program at the end of September, with the balance sheet level thereafter going sideways. Mr. Powell after the meeting said that he sees a balance sheet a bit above $3.5 trillion by year-end, down from the current $3.93 trillion.
The Fed is currently following a policy of “patience” whereby it is waiting for further developments before deciding whether to implement any new rate changes. Specifically, the FOMC in its last post-meeting statement said, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.”
While the Fed is anticipating an unchanged funds rate through year-end and one rate hike in 2020, the markets are much more dovish. The markets are discounting a 74% chance of a -25 bp rate cut by the end of this year and are discounting an overall -46 bp rate cut by the end of 2020, equivalent to 1.8 rate cuts, according to the federal funds futures markets.
The outcome of today’s FOMC meeting is expected to be uneventful with the Fed leaving its funds rate target unchanged and with the Fed at most filling in some further details about its plan to end its balance sheet drawdown program. However, there is an outside chance that the Fed today may announce a -5 bp cut in its IOER rate (interest on excess reserves) to push the effective funds rate lower.
The Fed’s general intent is for the federal funds rate to trade near the 2.375% midpoint of its target range of 2.25-2.50%. In reality, the funds rate in January and February traded right at the IOER rate of 2.40%, slightly above the 2.375% mid-point. Banks have no reason to loan money at a rate lower than 2.40% since those banks can get paid the IOER rate of 2.40% from the Fed by simply leaving those excess reserves in their account at the Fed. The IOER rate has therefore become effectively a floor for the federal funds rate. However, a problem has cropped up in the past few weeks since the funds rate has been creeping higher and hit 2.45% on Tuesday, which is only 5 bp below the upper range of 2.25-2.50% target range.
The markets are therefore on guard for the outside chance that the FOMC today might cut the IOER rate by -5 bp to 2.35% to push the effective funds rate back down towards the 2.375% target midpoint. The market consensus, however, is that the FOMC is likely to delay a decision on an IOER cut to see if the upward pressure on the funds rate abates. An IOER cut today would present the Fed with somewhat of a communication challenge of trying to explain to the public why it is cutting a key interest rate.
Post-agreement tariffs are a “major obstacle” for US/Chinese trade agreement–WSJ — The WSJ on Tuesday reported that the Trump administration’s intention of keeping some penalty tariffs in place even after a trade agreement is reached is a “major obstacle” to an agreement since China would consider such tariffs to be an affront. Nevertheless, the article cited an unnamed source as saying that the issue could possibly be addressed by an agreement by the U.S. to progressively remove all tariffs as certain agreement benchmarks are reached. The market’s reaction to a final trade agreement is likely to depend in large part on how many tariffs remain in place after the agreement is reached.
USTR Lighthizer and Treasury Secretary Mnuchin on Tuesday met with their Chinese counterparts in China. FT reported on Tuesday that next week’s US/Chinese meetings will be much more substantial than this week’s meetings with Chinese Vice Chair Liu this Sunday arriving in Washington with an many as 100 Chinese officials for five or six days of talks next week. The goal will be to have a final agreement by the end of next week and a date for a Trump-Xi signing summit in late May or early June.
ISM manufacturing index expected to show firm confidence — The consensus is for today’s Apr ISM manufacturing index to show a small -0.3 decline to 55.0, giving back part of March’s solid +1.1 point rise to 55.3. The rise in the ISM in March to 55.3 was a welcome development that suggested that the U.S. manufacturing sector remains in relatively good shape. Indeed, the April new orders sub-index rose by +1.9 points to the relatively strong level of 57.4, suggesting a good orders pipeline for the manufacturing sector.
ADP expected to rebound — The consensus is for today’s Apr ADP employment report to rebound upward to more of a trend increase of +180,000 from March’s weak report of +129,000. Friday’s payroll report is expected to show a similar increase of +187,000 after March’s +196,000 report.
