The Federal Open Market Committee (FOMC) is poised to cut the policy rate at its meeting on July 30–31, but members of the committee are divided. Markets are pricing a 25 basis point (bp) cut, and we believe that is the most likely outcome, but we also see a meaningful chance of a 50 bp cut.
Following the June 18–19 meeting, a majority of the FOMC was still in favor of keeping rates on hold through the end of 2019 (according to the Fed’s economic projections and “dot plot”). However, the tone of Fed communications has taken a somewhat more dovish shift in the weeks since. Of note, Fed Chair Jerome Powell, in his semiannual testimony before Congress last week (and during a dinner speech at the Bank of France on Tuesday), didn’t discuss the prospect of maintaining the current level of the interest rates (i.e., not cutting) – we see this as evidence that he and others on the Fed’s Board of Governors are in favor of easing and were very likely the participants forecasting at least 50 bps in rate cuts by the end of this year.
Why cut? Potential areas of concern in U.S. economy
With U.S. real GDP growth likely to average a solid 2.5% in the first half of 2019, and the unemployment rate sitting at 3.7% – a multi-decade low – various commentators have stated that the economic data don’t justify a rate cut. Furthermore, Powell and other FOMC officials have characterized the U.S. economy as “in a good place.” However, we see several compelling arguments for somewhat more accommodative monetary policy.
- Real growth in goods-producing sectors has decelerated materially. Despite solid overall GDP growth year-to-date, a closer look at the data reveals severely negative growth momentum in U.S. manufacturing, investment, and exports. And according to surveys, business confidence in the outlook has deteriorated.
- Labor market momentum is slowing. While our baseline outlook continues to be for a healthy U.S. consumer to support growth, there is a real risk that the areas of economic weakness spill over into labor markets and consumption more than expected. Payroll growth and (more importantly) aggregate hours worked are slowing as companies cut back hours and slow the pace of hiring in response to weaker sales growth.