FED is still minded to ease

>> What if the FED won’t be able to cut rates?

What do we mean by this? It implies a number of things, and we will focus on three. The first is that the Fed is reticent to talk up the possibility of rate hikes. The second is that ‘equivocal'-looking economic data, which could theoretically tip the Fed to either ease or hold rates, is more likely to prompt rate cuts. And the third is that, despite vehement denial by the Fed, political factors will be an issue in this election year. The upshot is that a rate cut, or cuts, are more likely than not this year.

The first point, which we saw from both the statement and Powell’s press conference, is that the Fed is reticent to endorse the idea that rates could have to rise again in the future. When pushed in the press conference on the possibility that inflation might not fall back to target as the Fed expects, Powell suggested that this would just lengthen the ‘hold’ period, not necessarily spark higher rates.

Of course, Powell could not afford to deny altogether the possibility that rates may have to rise again but the bar is very high for this. We sense this is the case because the Fed believes that its policy is working; that it is sufficiently restrictive and is reticent to endorse the idea that factors such as robust growth, inflation, asset prices and more are indicative of broader financial conditions being too loose.

In short, if anything is a problem, it is that more time is needed, not higher rates. Coming onto the second point, about a run of more ‘equivocal’ data, particularly on inflation, the Fed will not jump on this to justify a quick move to cut rates but will, nevertheless, slowly build the case for policy easing.

For while Powell continues to stress that the Fed wants to get inflation back to the 2% target, there is still no sense that this level has to be hit in order to fire the starting gun on rate cuts. Inflation only has to hover above 2% and look as if it will fall to 2% over time to justify policy easing.

The ECB, which looks almost certain to cut rates in June will do so against the backdrop of inflation that is still above 2% and is not projected to get there until 2025. Now clearly none of this argument applies if data are unequivocal, especially on inflation. If the numbers come through like they did in Q1 the Fed most probably won’t cut at all this year.

>> Will the FED act in a political way?

Instead, if the data lie somewhere in the middle ground, where both doves and hawks can claim victory, it will be the doves that win out through rate cuts. Steve Barrow, Head of Standard Bank G10 Strategy, thinks this is an important point to bear in mind because we suspect that the data will be equivocal with inflation numbers, for example, better than we saw in Q1 but not so clearly consistent with 2%, or sub-2% inflation levels that it makes even the most ardent Fed hawk roll over.

The final argument we would make is that there is an implicit, but certainly not explicit, political bias within the Fed. Understandably, Powell denied all talk of political bias in his press conference. He was right to do so and to point out that you will find no mention at all of election or political factors in any prior Fed transcript. But we’re not talking here about some sort of explicit political discussion within the Fed to adjust policy decisions because of the impending election. Instead, we’re thinking more of the inner political dialogue that goes on in the mind of individual FOMC members.

“For instance, might such an inner dialogue dissuade members from potentially creating a pre-election financial market upset by talking about the possibility of rate hikes? More than this, might the inner discussion within the minds of individual FOMC members be biased towards delivering the rate cuts that have been predicted for this year in order to appear as apolitical as possible? Or might some members even fear for democracy itself if Trump wins another term and hence see a decision to endorse rate cuts, not as a bias in favour of one party over another, but of democracy over something that might turn out to be much more sinister?”, said Steve Barrow.