US interest rates, an uncertain economic outlook: CommSec

EXPERT OBSERVER

US Federal Reserve meeting

As expected, the US Federal Reserve’s Open Market Committee (“FOMC”) unanimously kept the target range for the federal funds rate between 2.25-2.50 per cent.

FOMC members voted 9-1 to hold interest rates steady with St Louis Fed President James Bullard preferring a rate cut. 

US Federal Reserve Chair Jerome Powell said “The case for somewhat more accommodative policy has strengthened” at his press conference after the central bank announced its decision.

The median interest rate projection still shows interest rates unchanged at 2.4 per cent this year, before falling to 2.1 per cent in 2020, down from the previous forecast of 2.6 per cent in March.  

Changes in US monetary policy settings can affect rates in Australia as well as the sharemarket and currency.

What did the Fed decide and what does it all mean?

The US Federal Reserve has adopted a more ‘dovish’ policy stance, removing its previous reference to being “patient” with future rate adjustments. But the FOMC stopped short of signalling a July interest cut.

That said, the FOMC’s interest rate projections (‘dot plot’) showed 8 of 17 FOMC members projecting that interest rates will need to be cut this year, with seven of those officials seeing two 25 basis point rate cuts. 

In its statement, the FOMC cautioned that US economic growth was “moderate” and “uncertainties about this [economic] outlook have increased.” 

Further, the FOMC said “in light of these uncertainties and muted inflation pressures, the committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”

The median federal funds target projections were adjusted. There was no change in the projection for 2019 of 2.4 per cent. But the forecast for the federal funds rate in 2020 is now 2.1 per cent (previously 2.6 per cent) and in 2021 the fed funds rate is now seen at 2.4 per cent (previously 2.6 per cent). 

The FOMC updated its GDP and unemployment rate projections. The FOMC projects GDP growth of 2.1 per cent in 2019 (unchanged); 2.0 per cent in 2020 (previously 1.9 per cent), and 1.8 per cent in 2021 (unchanged).

Meanwhile, the FOMC expects the unemployment to be 3.6 per cent in 2019 (previously 3.7 per cent), 3.7 per cent in 2020 (previously 3.8 per cent) and 3.8 per cent in 2021 (previously 3.9 per cent). 

On consumer prices, core personal consumption expenditure (PCE) deflator (inflation) is expected to be 1.8 per cent in 2019 (previously 2.0 per cent), 1.9 per cent in 2020 (previously 2.0 per cent) and 2.0 per cent in 2021 (unchanged). 

What are the implications of today’s decision?

Commonwealth Bank Group economists now expect the FOMC to cut the federal funds rate by 25 basis points to a target range of 2.00-2.25 per cent at the next meeting on July 30-31. 

And further interest rate cuts are expected as US-China trade tensions weigh on US business investment and hiring intentions. Wages growth has softened and manufacturing activity is moderating. 

The fiscal stimulus from the Trump Administration is fading, as evidenced by lower corporate profitability in the March quarter. And inflation expectations are receding, with the recent drop in the University of Michigan’s longer-run inflation gauge to the lowest on record. 

Financial markets reacted by factoring in a 100 per cent probability of the FOMC cutting rates at its July meeting. 

US sharemarkets posted modest gains on Wednesday. Healthcare shares rose by 1 per cent, but banks lost 0.9 per cent. The Dow Jones index rose by 38 points or 0.2 per cent. The S&P500 index lifted by almost 9 points or 0.3 per cent and the Nasdaq rose by 33 points or 0.4 per cent.  

The Dow Jones is now just 1.2 per cent below its record high set in October, the S&P500 is 0.7 per cent short of its April record high, the Nasdaq is around 2 per cent below its high reached in May.  

Following the release of the FOMC statement, 2-year US Treasury yields declined by 8 points to 1.80 per cent, while 10-year US Treasury yields fell by 4 points to 2.04 per cent.  

The US dollar weakened following the FOMC’s announcement on growing interest rate cut expectations. The Bloomberg Dollar Index fell by 0.3 per cent. Overnight, the Aussie dollar rose from US68.54 cents to near US69.04 cents and was near US68.87 cents in late US trade.

Comparing the two most recent statements

The statement from the May 2019 meeting is on the left; the statement from today’s June 2019 meeting is on the right. Emphasis has been added to highlight key points in the wording in the statements.

FEDERAL RESERVE press release

For release at 2 p.m. EST May 1, 2019

Information received since the Federal Open Market Committee met in March indicates that the labor market remains strong and that economic activity rose at a solid rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Growth of household spending and business fixed investment slowed in the first quarter. On a 12-month basis, overall inflation and inflation for items other than food and energy have declined and are running below 2 percent. On balance, market-based measures of inflation compensation have remained low in recent months, and survey-based measures of longer-term inflation expectations are little changed.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes. In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Voting for the FOMC monetary policy action were: Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; James Bullard; Richard H. Clarida; Charles L. Evans; Esther L. George; Randal K. Quarles; and Eric S. Rosengren.

FEDERAL RESERVE press release

For release at 2 p.m. EST June 19, 2019 

Information received since the Federal Open Market Committee met in May indicates that the labor market remains strong and that economic activity is rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although growth of household spending appears to have picked up from earlier in the year, indicators of business fixed investment have been soft. On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation have declined; survey-based measures of longer-term inflation expectations are little changed.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Charles L. Evans; Esther L. George; Randal K. Quarles; and Eric S. Rosengren. Voting against the action was James Bullard, who preferred at this meeting to lower the target range for the federal funds rate by 25 basis points.

Ryan Felsman is a Senior Economist for CommSec