Most analysts expect the FOMC to vote unanimously to hold rates steady at 1.5%-1.75% tomorrow. Money market pricing supports this view; the probability of rates being held steady is seen at 87.3%.
For reference, the Fed has never failed to deliver in line with market expectations when pricing has been higher than 50%. In other words, when markets have priced more than 50% chance of a cut, a hold or a hike in the past, the Fed has never not gone with the market. If they did defy the market in this way, it would be seen as a catastrophic failure of Fed communication. As such, I wouldn’t expect any surprises tomorrow.
SO, what are the main reasons behind the Fed’s decision to hold likely to be?
Unemployment is at 50-year lows, equities prices elevated, the consumer and labour markets showing persistent strength and we have just turned a corner in the US/China trade war (the Phase One deal signing) that should signify that the worst is behind us. Therefore, the FOMC’s view that rates are appropriate at current levels looks intact for now.
However, those of a more dovish disposition are quick to point out that inflation is still running below target, US economic growth is still gradually slowing (many analysts see growth at sub-2% in 2020), and business investment is yet to show signs of a significant turnaround.
Moreover, they add that with Phase Two US/China trade negotiations and the US election ahead, uncertainties are still rampant, and business investment is unlikely to show a stunning rebound this year.
Potentially further complicating the Fed’s outlook is the recent outbreak of Chinese coronavirus. The virus’s impact on the Asia Pacific and the global economy is likely to be significant in 2020. Some analysts have gone as far as predicting a 2% hit to Chinese economic growth this year.
While we are on the topic, Chinese coronavirus has had a fairly significant impact on the market-implied probability for easing later in the year.
One week ago, pricing for a July rate cut was at 30%. Now, it’s at 50%. Chairman Powell is likely to be pressed to talk about the future path of rates during the press conference.
Elsewhere, we are expecting a technical adjustment to monetary policy in the form of a 5bps IOER rate hike. This will not be seen as a monetary policy signal, rather it will just be seen as the Fed trying to implement its current policy stance effectively.
In the Press Conference, expect Powell to refer to the Fed’s ongoing repo operations as also purely “technical.” Markets are much more skeptical on this front.
All in all, I wouldn’t expect fireworks out of this meeting (not like we saw with BoC last week anyway). But, given that markets see the Fed adopting a dovish bias in the coming months, it will be interesting to see how much, if at all, the Powell pushes back against this view.