By Michael O’Neill

The Federal Open Market Committee (FOMC) delivered.  They chopped the target range for federal funds by 0.25% to 2.00-2.25% on July 31.  The June statement telegraphed the cut, and to ensure markets got the message, it was followed up with a series of dovish speeches by Fed officials.  Financial markets shouldn’t have been surprised, and they weren’t.  Nevertheless,  Wall Street stocks declined, and the US dollar climbed after the news.

The FOMC statement was very similar to the one in June.  The opening paragraph is nearly identical, except the phrase “measures of inflation compensation have declined” became “remain low.” The major change came in the second paragraph.  The FOMC went from “uncertainties about this outlook have increased” to being spooked by “implications of global developments for the economic outlook as well as muted inflation pressures.” That was their excuse to cut rates.  Then they hedged their bet.  They wrote: “the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain.”

Oddly, that’s what they said in June, and they didn’t cut rates.  Did Mr Powell bow to President Trump’s wishes? 

The President was irked when Fed funds were left unchanged in June.  Since then, he threatened to fire Powell, disparaged his work, said “he doesn’t have a clue,” and complained, “We don’t have a Fed that knows what they’re doing.” Trump wasn’t mollified by the July 31 rate cut, either.  He tweeted, “What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world….  ….As usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place – no inflation. We are winning anyway, but I am certainly not getting much help from the Federal Reserve!”

During his press conference, Mr Powell denied being influenced by the President although he may have had his fingers crossed.

The July rate cut merely reversed the December 2019 rate increase.  In December, the Fed hiked because the Committee projected “growth continuing at healthy levels, the unemployment rate falling a bit further next year, and inflation remaining near 2 percent.” The Committee noted risks from “cross-currents” which were described as “global growth concerns and trade tensions.”

In July, the Fed cut rates “to insure against downside risks from weak global growth and trade policy uncertainty; to help offset the effects these factors are currently having on the economy; and to promote a faster return of inflation to our symmetric 2 percent objective.”

The Fed seems to be chasing its tail.   They just cut interest rates for almost the same reasons they gave for raising them.  The July 31 rate move may be an “insurance cut,” a hawkish cut, or merely a “mid-cycle policy adjustment as claimed by Mr Powell.  Whatever it is, it is not a roadmap for future monetary policy decisions.

“round and round the Fed goes”

The Fed may not be sure of their next move, but the European Central Bank has a plan.  On July 25,  ECB President Mario Draghi warned that “the outcome of the economic analysis with the signals coming from the monetary analysis confirmed that an ample degree of monetary accommodation is still necessary for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.” That is “central bank-speak” for “rate cuts are coming, and ECB rates are already negative.

The ECB deposit facility rate is -0.40%, the Swiss National Bank (SNB) sight deposit rate is a negative 0.75% and Bank of Japan (BoJ) short- term rates are -0.10%. 

SNB President Thomas Jordan may be forced to cut interest rates further to combat additional ECB stimulus and Swiss franc strength.  BoJ Governor Haruhiko Kuroda warned the bank would act “pre-emptively” against risks to the economy from “protectionist policies” and trade woes.  Bank of England rates could drop if a “no-deal Brexit” occurs on October 31.  The Reserve Bank of Australia and the Reserve Bank of New Zealand have cut rates  this year and are expected to deliver more policy easing.

The Bank of Canada is the odd-man out.  In the game of “easy money” musical chairs, Governor Stephen Poloz and company are left without a seat due to their “neutral policy” stance.  They are not in any hurry to reduce rates.  The BoC noted “Canada’s economy is returning to growth around potential, as expected,” a surge in oil prices, a healthy labour market supporting consumption and inflation at target.

Fortunately for the Canadian dollar, FX traders are content to buy US dollars in the belief that the Fed is “less dovish” than the rest of the major central banks.   However, USDCAD gains may be shallow.  Rising crude oil prices,  strong domestic data  and a long term  down trendline may cap moves at  1.3500 or about 74 US cents to the Canadian dollar.

The FOMC chose to cut interest rates to support their favourable outlook for the US economy.  The BoC chose to leave rates unchanged for a similar reason.  The risks are the same, but the results are different.  Only time will tell which bank made the right move.