Giving Credit Where Credit Is Due

As expected, the Fed lowered short-term interest rates and officials remained divided about what to do next. The policy meeting came in a week that saw elevated funding pressures in money markets, which drove the effective federal funds rate above the top of the target range. On Friday, the New York Fed announced a series of overnight and term repurchase agreement (repo) operations to October 10, which should take care of things. However, the developments highlighted concerns about whether the Fed will need to embark, earlier than anticipated, on “organic” quantitative easing to ensure that there is an adequate amount of reserves in the system.

It is well known that Fed officials have been divided on the appropriate stance of monetary policy. In June, when the Fed left rates steady, officials fell evenly into two camps, those expecting no change in rates through the end of the year and those anticipating a half-point cut. The minutes from July 30-31 policy meeting, when the Fed cut by 25 basis point, showed that “several” officials favored leaving rates unchanged. At the September 17-18 meeting, two of the ten voting officials dissented in favor of no change, while one dissented in favor of a 50-bp cut. The revised dot plot (the forecasts of the appropriate year end federal funds target rate made by each of 17 senior Fed officials, not all of whom vote on policy) showed a three way split in the outlook through the end of the year. Five officials presumably did not want a cut at the September meeting, five officials anticipate no further rate cuts this year, and seven expect another 25-bp cut.

Scott Brown
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It is also well known that officials are divided on the benefits of the dot plot. Some note the tendency of market participants to misinterpret the results as signaling a committed policy path. Others, including Chair Powell, believe it to be an important communications tool, but one that needs to be explained better. It’s useful to look at where the Fed has come over time. A year ago, when the federal funds target range was 2.00-2.50%, officials expected further rate increases. That was the case in December as well, when the target range was raised to 2.25-2.50%. The dots shifted toward neutral in March, down further in June. The dots merely reflect an assessment of where the economy is headed, and that will change.

This year, the household sector fundamentals have remained solid. Consumer spending, which account for 68% of Gross Domestic Product, should continue to propel the overall economy. In contrast, slower global growth and trade policy uncertainty have weighed against business fixed investment. Moreover, the impact of trade tensions on the economy are being felt increasingly. Businesses report that they can’t get price quotes for next year’s supplies. Fearing the tariffs on consumer goods set for December 15, some are stockpiling goods and materials in advance. Many doubt that they will be able to pass higher costs along. In his post-FOMC press conference, Chair Powell noted that “our business contacts around the country have been telling us that uncertainty about trade policy has discouraged them from investing in their businesses.”