Ever since the so-called pause in the Fed’s tightening cycle, a cut in Fed funds was inevitable, writes Landon Whaley.
Since early January, when Federal Reserve Chairman Jerome Powell did his M.C. Hammer-esque dovish pivot, I’ve been calling for the Fed to tilt full dovish. This past week we got the tilt with key Fed members whispering dovish sweet nothings into the ears of jubilant investors.
St. Louis Fed President James Bullard got the dovish party started by saying “A downward policy rate adjustment may be warranted soon to help re-center inflation and inflation expectations at target and also to provide some insurance in case of a sharper-than-expected slowdown...” He then doubled down, stating, “Even if the sharper-than-expected slowdown does not materialize, a rate cut would only mean that inflation and inflation expectations return to target more rapidly." Bullard’s telling us a rate cut is coming, even if the data doesn’t necessitate one.
His comments were followed by Fed Chair Powell dovishly crying in a speech to the Chicago Fed, “We are closely monitoring the implications of these [trade war] developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2% objective.”
And if the “…act as appropriate to sustain the expansion…” wasn’t dovish enough for you, how about “[interest rates so close to zero] has become the preeminent monetary policy challenge of our time…perhaps it is time to retire the term 'unconventional' when referring to tools that were used in the 2008 Credit Crisis. We know that tools like these are likely to be needed in some form in the future." Like my boy, Emeril would say, “BAM!”
Powell wants policy tools that are usually reserved for crisis-type environments to be used in a run of the mill economic slowdowns! Japan, here we come!
While the full tilt dovish rhetoric came earlier than I anticipated, I can’t understand why markets reacted as if it came out of nowhere. As we discussed on several occasions early in the year, the Fed never “pauses,” as everyone was lamenting. Once the Fed stops raising rates, their next policy action is always a rate cut, always!
After the March meeting, when the Fed arrested rate hikes, an eventual rate cut was a done deal. September is as good a time as any to rip the rate cut band-aid off given that by then, U.S. growth will have been slowing for almost 12 months and we will be two to three months into a disinflationary impulse.
The market (Fed Fund futures) is now pricing in an 85% chance of a September rate cut, which means the next three months will be spent obsessing over the size of the cut. I have no clue whether we’ll get 25-, 50-, 75-, or even Trump and Pence’s preferred 100-basis point cut. The magnitude of the cut will depend on how fast growth deteriorates from here, how volatile markets become and whether inflation softens slowly, or all at once (and probably how many times the Tweeter-in-Chief chirps at Powell publicly).
Luckily for us, we don’t have to be Miss Cleo to trade the next three months successfully, or to be positioned appropriately for whatever size rate cut comes our way. We will continue to trade the long side of utilities, REITs, Treasuries and on the first pullback, we’ll be jumping into gold as well. These markets will perform well as we traverse the Winter environment between now and September and more importantly, once the rate cut becomes a reality, those same markets will receive a huge bullish shot in the arm.
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