If you’ve followed our Federal Reserve coverage this year, a recurring theme has emerged: The Fed doesn’t mind being predictable. That is, when the market largely expects a rate cut, the central bank tends to follow through.
Prior to the Fed’s meeting this week, the CME FedWatch tool, which measures trading in fed funds futures, indicated expectations for a 0.25 percent cut reached 99.5 percent. And, as expected, the Fed cut its key rate a quarter point Wednesday, delivering markets a treat rather than a trick the day before Halloween. Wednesday’s move represents just the third cut in more than a decade, but all three have come in consecutive Fed meetings this year.
“We’ve long said that the Fed is now trade-war dependent and not necessarily data dependent, but the data has weakened a bit lately as trade concerns linger,” says Brent Schutte, chief investment strategist at Northwestern Mutual. “The Fed would rather err on the side of being too accommodative rather than not enough.”
While a quarter-point cut was largely priced into markets by Wednesday, investors were keenly focused on how Fed Chairman Jerome Powell framed the bank’s next steps: Would this be three cuts and out, or would Powell leave the door open to more rate cuts in the future? The Fed remained strategically vague on this front. In June, it stated it would “act as appropriate to sustain the expansion,” but that clause was slightly tempered in its most recent statement.
“The Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate,” the Fed said in a statement.
“This wait-and-see approach reflects the recent tamping down of the trade war uncertainty and the Fed wanting to see what the impact of their recent stimulus. But make no mistake – if trade uncertainty ramps up or the economy falters, we believe the Fed will pivot back to easing quickly,” says Schutte. "Overall, the Fed removed a promise to cut rates in the nearer term. Most importantly, it clarified that its bar for raising rates, and pushing the economy into submission, is very high. This is something we've been saying for quite some time now."
A LITTLE INSURANCE
Like the prior two cuts, the move is largely viewed as an “insurance” measure to help bolster the economy as the world navigates trade spats and global growth concerns. The move comes at a key juncture in the U.S., as holiday spending is set to ramp up in the coming weeks. The numbers also back the Fed’s move. Trade uncertainty has washed onto U.S. shores and has negatively impacted corporate earnings — namely for trade-sensitive firms. And, over the past few months, growth in manufacturing and the services sector of the U.S. economy has decelerated.
Despite these headwinds, Schutte’s outlook hasn’t changed: The data doesn’t point to a recession occurring soon; rather, a political miscalculation remains the biggest recessionary risk. Schutte believes the Fed will continue to remain accommodative, so long as political risks abound.
“Absent a policy mistake, our research continues to show few reasons for the U.S. economy to fall into recession — at least from a traditional economic cycle perspective,” Schutte noted in a recent commentary. “Ultimately, easing or escalating political risk could be the X factor that pushes us further into an economic expansion or slips us into a future recession. ”
That point was driven home recently by Andrew Bonfield, chief financial officer of construction equipment manufacturer Caterpillar, a company long viewed as a bellwether of the global economy. Caterpillar reported declines in sales and profit for the third quarter and expects demand to soften going into the fourth quarter. However, there’s nuance behind the headline numbers.
“People who are buying large capital equipment are impacted by the uncertainty in the global economy,” Bonfield said in an interview with the Wall Street Journal. “Our customers are not in financial difficulties. Our customers are being cautious.”
ARE SOME CLOUDS CLEARING?
There are some indications that the Fed could take its foot off the accommodation gas pedal going forward. That’s because, although uncertainties remain, the biggest fears dragging on sentiment are showing signs of receding — if only slightly.
For one, the U.S. and China have significantly changed their tone on trade. Rather than escalating tensions, both sides have recently moved to de-escalate the drama. Earlier this month, President Donald Trump announced the two countries were working toward a “phase one” deal in which the U.S. would delay tariffs in exchange for China increasing its agricultural purchases from U.S. farmers. Last week, the Office of the U.S. Trade Representative announced that both countries had made progress finalizing parts of this deal, which could be unveiled sometime in November.
Schutte added that leading economic indicators around the globe, which have been in steady decline, are showing signs of stabilizing and could be poised to tick back upward. And, here in the U.S., Schutte is seeing signs that the Fed’s rate cuts are beginning to filter through the broader economy, particularly in the housing sector.
The National Association of Home Builders, for example, earlier this month reported builder sentiment rose to its highest level since February 2018, driven by a plunge in mortgage rates. While the Fed funds rate and mortgage rates tend to move in the same direction, mortgage rates are affected by several factors in addition to the Fed’s rate. It’s hard to say which factor is doing the pulling. Regardless, these are all positive economic signals, which means the Fed may not need to cut any further in the months ahead.
Still, it’s important to keep in mind that politics remains the wild card that could change the calculus in an instant — no matter the fundamentals.
“Never in my investment career can I recall political ‘happenings’ carrying so much weight in daily market movements,” says Schutte.
In this economy, a little certainty could go a long way.