No Surprises: Fed Leaves Rates Unchanged Again, Citing Slow Inflation Picture

The Fed has gathered three times this year, and so far it hasn’t moved rates an inch.

The latest non-move by the central bank came Wednesday, when it probably surprised almost no one by leaving its target range for the federal funds rate at between 2.25% to 2.5 percent, where it’s been since late December. That squared with futures market projections going into the meeting. Looking ahead, the Fed pledged to be “patient” as it determines its next move, which many analysts say is more likely to be down than up.

Asked in his post-meeting press conference what kind of circumstances might lead the Fed to consider a rate cut, Fed Chair Jerome Powell replied, “We don’t see a strong case for moving in either direction,” and that the Fed is comfortable with its current target range. 

The Fed arguably finds itself in a place where quick moves might not be needed. Economic growth of 3.2% in Q1 was strong, but inflation remains hard to find despite a historically low jobless rate. That fits pretty well with the Fed’s “dual mandate” of fostering economic conditions that achieve both stable prices and maximum sustainable employment.

At the same time, overseas growth in China and Europe continues to be on the soft side, which also lessens pressure on the Fed to tighten policy. 

The Fed did cite some improvement overseas recently and the push back of a possible disorderly Brexit.

It also pointed to improvement in the U.S. economy, saying the labor market remains strong and economic activity rose “at a solid rate.” That was a change from the last meeting, when it said economic activity had slowed. It also pointed to slowness in Q1 household spending and business fixed investment, something that’s been a trend for a while now. Powell said in his press conference Wednesday he expects those factors to bounce back.

The Fed also noted declining inflation both overall and for items other than food and energy. That was a change from last time, when it noted that lower energy costs had pushed inflation down. Powell said the fall in core inflation was a surprise, but he expects inflation to return to 2% over time.

Stocks moved up just a little after the Fed statement, after trading near unchanged earlier in the session. U.S. 10-year Treasury yields, which had been down going into midday, fell a bit more and recently traded near 2.46%. However, as time passed, stocks fell later in the session, possibly due to disappointment that Powell hadn’t indicated support for a future rate cut.

Where’s the Drama?

Just a few months ago, almost every Fed huddle drew lots of noise from the sidelines as the decision neared. The Fed was in a hiking mode, but by Q4, with the economy slowing and the stock market on the run, there was all kinds of drama about whether Powell and company would actually pull the trigger. When they did in late December, raising rates for the fourth time in 2018, the market promptly plunged to new lows for the year.

It’s a new day at Fed headquarters on Constitution Avenue. As almost anyone closely following the interest rate picture probably knows by now, the Fed is determined to be “data dependent,” meaning it doesn’t appear to be leaning in any particular direction for now on rates  Stocks are back to record highs for the first time since last September. 

The first two Federal Open Market Committee (FOMC) meetings this year came and went with no changes in the target range for the federal funds rate. It remains at the highest level since before the 2008 recession, with all the hikes coming since the end of 2015. 

Going into today’s meeting, investors seemed to expect more of the same. Odds were 98% of the Fed holding steady on rates with 2% chances of a 25-basis point rate cut, CME futures indicated on Monday. Looking ahead to June, chances of a rate cut were around 21%, with chances for lower rates rising to more than 65% by the end of the year. The Fed hasn’t cut rates since the 2008-09 recession.

Immediately after the meeting, CME futures indicated slightly higher chances of a June rate cut, around 25%. Odd of at least one rate cut by the end of the year rose to around 75%.

Analysts speaking soon after the Fed decision said it’s possible the Fed could be setting up investors for a potential cut in rates by talking up the low-inflation environment. We’ll have to wait and see. Those CME futures could be worth watching in coming weeks to see which way they move.

What’s In the Balance

With rate moves not really in the picture, some of the attention lately turned to the Fed’s balance sheet normalization program. Last time out, in late March, the Fed said it intended to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from $30 billion to $15 billion beginning this month. The reduction program would end in September, the Fed said.

At the time, that announcement might have soothed some investors who worried that the Fed might put more pressure on bond prices (and stir up possible higher borrowing costs) through reducing its holdings, which would add to supply. However, with 10-year yields now at around 2.5%, down 75 basis points or so from highs last fall, some question whether that’s really something to worry about. One school of thought suggests the Fed should continue the reduction program so it can have more traction the next time the economy goes into recession. 

With the federal funds rate still at low levels from a historic standpoint, the argument goes, the Fed might need more powder from quantitative easing if a recession hits, simply because it won’t be able to reduce rates by all that much before hitting zero. The Fed’s balance sheet now stands near $3.9 trillion, down from a peak of $4.5 trillion but still very high by historic standards. A lower balance sheet, some analysts say, would give the Fed more QE ammunition in the future.

You can never rule it out, but a recession seems unlikely in the near future with gross domestic product rising 3.2% in Q1, according to the government’s first estimate. However, the core personal consumption expenditure (PCE) price index—which the Fed closely watches for signs of inflation—was flat from the previous month in March, possibly a sign of some economic weakness. For the year, it was up just 1.6%, below the Fed’s 2% target.

The low inflation and a few other signs of sluggishness in the U.S. and overseas economies led to some talk this week about the chances of the Fed lowering rates sometime in the near future. The latest came Tuesday when President Trump urged rate cuts. However, it would be pretty unprecedented to see rate cuts when GDP is growing more than 3% and unemployment is below 4%.

Figure 1: Big Reversal: This 9-month chart, going back to early August, shows how 10-year yields (candlestick) have reversed their upward path even as the S&P 500 Index (purple line) bottomed out in December and rose sharply as the Fed stepped back from rate hikes. Data Sources: Cboe, S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Beyond GDP, Some Softness: There’s been a lot of chirping about last Friday’s better-than-expected Q1 gross domestic product (GDP) read of 3.2%, but since then the economic data hasn’t had as much pizzazz. Going into today’s Fed meeting conclusion, both March construction spending and the April ISM Manufacturing numbers came in below analysts’ expectations. Mortgage applications fell pretty sharply last week, and the personal consumption expenditure (PCE) price index for March also failed to shine. Chicago PMI for April looked particularly flat at 52.6, the lowest level since January 2017. As Briefing.com noted, most of the Chicago PMI barometers have fallen below their 12-month averages, “which suggests greater business uncertainty among firms.” So when the Fed potentially is asked to respond at today’s press conference to that solid GDP figure, keep in mind that things haven’t all been so hot lately, meaning the Fed’s warnings about economic slowness haven’t necessarily been off base.

Pondering Payrolls: Friday brings what’s arguably the most important data point of the month when April payrolls bow at 8:30 a.m. ET. Looking back at March, 196,000 jobs were created, about 20,000 above expectations, and way above the growth of 33,000 in February. Within those numbers, job growth in manufacturing and construction stagnated, while we saw stronger gains in health care and business and professional services. Average hourly wages grew 3.2% year-over-year.

So what are analysts looking for on Friday? Job growth is expected to be around 200,000, according to a Briefing.com consensus, with unemployment holding steady at 3.8% and hourly pay up 0.3% from the month before. That would be a bigger rise in wages than the 0.1% monthly increase seen in March. Investors might want to keep a close eye on construction and manufacturing jobs to see if they popped back in April after some weak months.

Infrastructure Alert: After a more than two-year wait, it looks like we’re seeing some traction on a  Washington plan to put money into infrastructure spending. Democrats and President Trump appear to be planning to spend as much as $2 trillion on highways, bridges, railroad, and broadband, The New York Times reported this week. While there wasn’t really much of a market reaction, we’ve said here before that infrastructure spending could be a possible boost to companies in the Industrial, Materials, and Tech sectors, with Tech potentially benefiting if part of the plan includes broadband. Transport companies like shippers and railroads also come to mind as conceivably getting a boost if modernization of roads and railroads comes into play, and it could also help the Walmart Inc's WMT and Amazon.com, Inc.’s AMZN of the world that rely on shippers to get their products quickly to customers. Some pundits are already writing this one off as unlikely, so don’t necessarily hold your breath. However, with a big election year ahead, it’s possible both parties might see benefits.

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