Phillip Macro – 5 key points arising from July FOMC Meeting August 1, 2019 98

Federal Reserve ends quantitative tightening and cuts rate for the first time since 2015

On 31 July 2019, Fed Chairman Jerome Powell announced the much anticipated rate cut of 25bps. This is the first time that the Fed has cut interest rate after 9 consecutive rate hikes since the quantitative tightening cycle began in December 2015.

1.       Mid-cycle adjustment to protect against downside risks: The Fed reduced the Fed funds rates by 25bps instead of a bigger 50bps as predicted by the Fed funds futures prices, bringing the Fed funds rate to between 2.00% and 2.25%. Jerome Powell stated that the cut is a “mid-cycle adjustment to policy” which would provide some buffer against downside risks.

2.       GDP data point to continued strength in the economy: The assessment of the economic outlook was similar, if not identical, to the one provided in June. The Fed mentioned that the labour market conditions were still strong. In the press conference, Jerome Powell mentioned that the June job growth data “point to continued strength” and they expect job growth to be slower but is enough to “hold the unemployment rate steady”. GDP growth was moderate and “came in close to expectations”. This illustrates that the Fed remained confident of the US economic strength. It is consistent with the recent GDP growth data, which remain healthy albeit slowing to 2.1% annualised in Q2.

3.       A steady rise in inflation and record-low unemployment: Core PCE index has rebounded slightly to 1.61% YoY (May 2019: 1.49% YoY) in June 2019. It grew 2.5% annualised over the past three months, as compared to 1.7% in the three months through May. With retail sales still strong and consumer confidence rising to an eight-month high, it is likely that the core PCE index will move towards the 2% target in 2H 2019 at a steady pace. Meanwhile, the unemployment rate has edged higher to 3.7% in June due to an increase in the labour force participation rate. However, unemployment rate is still at 50-year lows and close to the 3.6% unemployment target of the Fed. 

4.       More “hawkish” tone by the FOMC: The new statement issued by the FOMC highlights that the Fed will “continue to monitor” data in deciding on further rate cuts. This is a step-down from the “closely monitor” language used previously by the Fed to signal an imminent shift in policy rate. This may indicate that the Fed does not see much justification to warrant a further rate cut any time soon.

5.       Quantitative easing to cease in August: The Fed also announced its decision to reduce its balance sheet, two months earlier than previously indicated. However, the impact on the Treasury market may be muted with the suspension of the debt ceiling. Treasury plans to maintain the high level of debt issuance in 2H 2019, which would offset the reduction in the balance sheet.

In summary, we think that it is unlikely for the Fed to cut rates during the September meeting. The healthy GDP growth, accelerating inflation and record-low unemployment point to continued momentum for expansion. In our view, the next rate cut is likely to be near the end of the year when there would be a much clearer sign of a slowdown in GDP growth.  The Fed fund futures are anticipating one more rate cut this year, but continue to expect two rather than one rate cuts next year.

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Edmund Xue
Research Analyst
Phillip Securities Research Pte Ltd

Edmund covers the US Market Strategy. He was previously a risk transformation consultant in the Big Four.

He graduated with a Bachelor of Accountancy (Honours) with a major in Finance from the National University of Singapore.

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