Federal Reserve prepares for tough balancing act

Federal Reserve prepares for tough balancing act

At the Federal Reserve’s meeting on monetary policy next week, its chairman Jay Powell will face an unenviable task: to appease a market that has already priced in an aggressive easing cycle, but avoid overcommitting to subsequent rate cuts and buoying expectations even higher.Mr Powell failed to strike this balance at the US central bank’s most recent meeting in July, provoking criticism and a volatile market reaction. Investors should gird themselves to be disappointed once again.A little less than seven weeks ago, a phrase uttered by Mr Powell bewildered investors. By framing the first interest rate cut in 11 years as a “mid-cycle adjustment to policy” during the post-meeting press conference, the central bank chairman muddied the waters of what many had assumed was the start of a full-blown easing cycle. US stocks did recover somewhat after Mr Powell clarified he did not mean there would be “just one” interest rate cut. But markets were already on the back foot, struggling to read the mixed signals.Mr Powell has avoided using that term in the weeks since, and investors say he is unlikely to do so again on Wednesday. But few are convinced the Fed will be able to strike the right mood music for the capital markets — something that holds just as much importance as the quarter-point rate cut already priced in for September, according to Robert Rosener, an economist at Morgan Stanley. “The policy guidance and projection materials released will be as much in focus as the rate cut itself, and that is where the Fed has more scope to underwhelm,” he said.With all eyes on Mr Powell and markets clinging to every word, Wednesday’s announcement will be a “balancing exercise in communication”, said Shahid Ladha, the head of strategy for G10 rates at banking group BNP Paribas.“They are trying to satisfy the market without spurring them to price in more,” he said, noting the central bank must signal a cautious approach to future rate hikes while using slightly more dovish rhetoric to avoid a repeat of July’s communications mishap. Markets are currently pricing in a total of around one full percentage point worth of cuts to the Fed’s benchmark interest rate by the end of next year, according to futures prices compiled by Bloomberg.To walk this tightrope, the Fed must emphasise a point it has repeatedly made about the global factors clouding the growth outlook, and at the same time provide assurance the US economy is on relatively firm footing. On the global front, making that case is not difficult to do, given the German economy is teetering on the brink of recession and the industrial sector in China is beginning to stall. And while trade tensions between the US and China have eased somewhat in recent weeks, a deal between the two superpowers remains a distant prospect. Domestically, a tight labour market and strong consumer point to a US economy in decent shape. Manufacturing has suffered somewhat at the hands of the US-China trade dispute, with the sector contracting for the first time in three years last month, as has business sentiment. But the services side of the economy has continually outpaced analysts’ forecasts.In fact, Mr Powell himself painted a rosy picture of the US economy this month in Zurich when he said not only was the central bank not forecasting or expecting a recession, but also “the most likely outlook for the US is still moderate growth, a strong labour market and inflation continuing to move back up.”For this reason Steven Oh, the global head of credit and fixed income at PineBridge Investments, points out the two Fed officials who dissented from July’s rate cut — Esther George of the Kansas City Fed and Eric Rosengren of Boston’s — may have an even better case to make to toe a more hawkish line.“If you’re a dissenter, you may even more strongly dissent this meeting because the economic data has not changed at all,” despite a material slowdown in global growth and a worsening of the trade war, Mr Oh said.Given the lack of consensus within the Fed on the way ahead, and the elevated levels of market expectations, Kathy Jones, chief fixed-income strategist at wealth manager Charles Schwab, said Mr Powell does not have the scope to issue a “whatever it takes” kind of statement made by European Central Bank president Mario Draghi back in 2012 amid the euro crisis.So while Mr Draghi was able to outdo market expectations on Thursday with his announcement of an ambitious stimulus package, Mr Powell is unlikely to be able to match his European counterpart.


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