- FOMC’s policy-hold depends on the uncertain trade outlook
- Trump decision is down to the wire on Sunday’s new China tariff
- U.S. core CPI expected little changed
FOMC’s policy-hold depends on the uncertain trade outlook — The FOMC at its 2-day meeting that concludes today is unanimously expected to leave interest rates unchanged with its funds-rate target at 1.50%/1.75% and the IOER rate at 1.55%. The probability of a rate cut today is zero, according to the federal funds futures market.
The FOMC has cut the funds rate by -25 bp at each of the last three meetings starting in July and ending in October. The funds rate target is now at 1.50%/1.75%, down by -75 bp from the target of 2.25%/2.50% seen in the first half of this year. The FOMC was forced into this year’s -75 bp rate cut by the downturn in the global economy caused by the trade war. However, the FOMC has now clearly signaled that its preventative rate-cut move is over and that rates will remain unchanged over the medium term.
While the Fed is claiming that its policy is unchanged, the reality is that the future is very uncertain. The near-term economic outlook will look considerably more stable if President Trump defers Sunday’s tariff and if there is a US/Chinese phase-one trade deal within the next few weeks. In that case, the Fed will likely leave rates unchanged through 2020 and possibly raise rates by a notch in 2021.
However, if the US/Chinese trade talks should unexpectedly break down, and if President Trump imposes new rounds of tariffs on Chinese goods, then the global economic outlook will quickly turn bleak, and the Fed will likely need to start cutting rates again in early 2020. Thus, even though the Fed seems confident about its forecast for unchanged rates, the reality is that the Fed’s future policy path is highly uncertain because it depends on the unpredictable outcome of US/Chinese trade relations.
Since the market is unanimously expecting rates to remain unchanged today, the markets will be looking for any market-moving news to come from Fed Chair Powell’s press conference or the new Fed dots. The last set of Fed dots from the Sep 17-18 meeting (two meetings ago) is obsolete since the Fed at its following meeting on Oct 28-29 cut the funds rate by -25 bp to 1.50/1.75%, a move that was not predicted in the Sep Fed dots. The Sep Fed dots forecasted an unchanged fed funds target of 1.75%/2.00% through the end of 2020, and then one 25 bp rate hike in 2021 and a second rate hike in 2022, leaving the funds rate at 2.25/2.50% by the end of 2022.
Today’s new Fed-dot forecast is likely to show a median forecast for an unchanged funds rate of 1.50%/1.75% at least through the end of 2020. The question is whether the Fed will then add a rate hike in 2021 and a second rate hike in 2022 as it did in the September Fed dots.
The Fed today might want to avoid a rate-hike forecast for 2021 so that the Fed delivers a more neutral policy message and doesn’t cause the markets to think too much about the Fed’s next rate hike. Fed Chair Powell at the last FOMC meeting, waved off the next rate hike by saying, “We would need to see a really significant move up in inflation that’s persistent before we even consider raising rates.” The markets today would react bearishly if the Fed dots should unexpectedly forecast a +25 bp rate hike in 2020. The markets remain much more dovish than the Fed and are discounting a -25 bp rate cut in Q4-2020.
Trump decision is down to the wire on Sunday’s new China tariff — The markets remain on edge about whether President Trump on Sunday will go ahead with his plan to slap a 15% tariff on the last $160 billion of Chinese goods. At that point, the U.S. would have tariffs on virtually all imports from China, i.e., a 25% tariff on $250 billion of goods and a 15% tariff on about $270 billion of goods.
A US/Chinese trade deal does not appear to be imminent, but the markets appear to be optimistic that President Trump will defer Sunday’s tariff as the two sides work towards a phase-one trade deal. Bloomberg on Tuesday reported that China officials expect President Trump to delay Sunday’s tariffs to give more time for trade negotiations.
However, White House advisor Kudlow threw some cold water on the Bloomberg report later in the day when he said that President Trump has not yet made a decision about Sunday’s tariff and that, “The reality is that those tariffs are still on the table.” White House trade advisor Navarro late Tuesday then threw even more cold water on the Bloomberg report by saying that he sees “no indication” that Sunday’s tariff will be delayed. There is the possibility that the Bloomberg report may have represented some wishful thinking from Chinese officials rather than any hard reality about the odds for Sunday’s tariff.
Bloomberg in Tuesday’s article quoted sources as saying that President Trump is expected to meet with his trade team on Thursday for a tariff decision. Bloomberg said that the main sticking point continues to be Chinese purchases of U.S. ag products. Bloomberg also noted that the two sides are now discussing the reduction of the rates on existing tariffs, as opposed to previous Chinese demands for the removal of at least some of the existing tariffs.
U.S. core CPI expected little changed — The consensus is for today’s Nov CPI to edge higher to +2.0% y/y from Oct’s +1.8%, and for the Nov core CPI to be unchanged from Oct’s +2.3%. The Oct core CPI of +2.3% y/y was somewhat elevated at only 0.1 point below the 11-year high of +2.4% posted in Aug-Sep. However, the PCE deflator, the Fed’s preferred inflation measure, was in weaker shape at +1.3% y/y headline and +1.6% y/y core in October, comfortably below the Fed’s +2.0% inflation target. Meanwhile, the current 10-year breakeven inflation expectations rate of 1.71% is also comfortably below the Fed’s +2.0% inflation target, although that it is just mildly below Nov’s 4-month high of 1.74%.
