This week the Federal Reserve will meet to make their policy decision for the Federal Funds Rate. Last meeting, the Fed lowered their target rate for the first time since 2008, citing global trade tensions, slowing global growth and muted inflation as the primary contributors to their decision. At the annual Jackson Hole Symposium, Powell hinted towards further easing while reiterating the three previous issues.
What has happened to those three key issues since the last FOMC meeting?
Chairman Powell pointed to 3 key issues during his public appearance in Jackson Hole, WY. He indicated that these issues would be major drivers in future policy decisions.
Issue #1: Trade Tensions
First, trade tensions have been a lingering issue. The White House has put forth plans to increase tariffs on $250M of Chinese imports. These tariffs range from 25%-30% on various goods, but they have since been postponed until after their next meeting with top Chinese Officials.
In response to postponing of these tariffs, China has lifted its own tariffs on some key U.S. imports, while attempting to make arrangements for the purchase of some U.S. agricultural products. It seems both sides are showing openness to making concessions in order to come to an agreement, but only time will tell. The next talks are scheduled to be at least two weeks after this week’s FOMC meeting.
Issue #2: Slowing Global Growth
Second, slowing global growth has been driven primarily by the increase in trade tensions and a loss of business sentiment that followed. Last week, the European Central Bank lowered their key market rate to -0.5% and reinstated a bond purchasing program, also known as quantitative easing (QE). The Euro-zone’s growth has been slowing, led by the robust German economy. As one might predict, their export heavy economy is suffering mightily from the lack of trade throughout the world. The move by the ECB into negative rates was met with heavy opposition among their rate setting committee, member central bankers, and the White House.
China’s economy has been weakening further as well. Following the slowest GDP growth quarter in 27 years, Chinese industry has been producing below economists’ predictions in July and even further below their expectations in August. This news prompted China to consider fiscal and monetary stimulus of its own. The White House is hoping these deflationary pressures will force China’s hand in trade negotiations to avoid further damage to manufacturing in China.
Issue #3: Muted Inflation
Finally, inflation has been moving in the right direction since the last FOMC meeting. Core CPI, which excludes volatile food and energy costs, increased by 2.4% compared to 12 months prior, the largest gain since July 2018. The Fed’s preferred inflation measure, the core PCE price index, increased 1.6% in the same 12-month time period. While the core CPI is above the Fed’s target, the core PCE price index is not, and that leaves the door open for further Fed stimulus to push it further toward the 2% goal.
How has the economic landscape changed since the last FOMC meeting?
While several headwinds have been hitting the U.S. economy for most of the summer, it seems that some have gotten stronger while others have gotten weaker. On one hand, inflation has been ticking in the right direction as China and the U.S. seem keen on making concessions for win-win trade deal. On the other hand, Chinese growth is slowing below forecasts and global growth seems to have stagnated.
The Fed also faces a U.S. economy that has so far weathered the storm. Consumption has sustained amid global tensions, and while the job market seems to be cooling, unemployment stays near record lows. However, it may be tough for the Fed to keep rates steady.
Many governments such as Japan, China and the EU have either already lowered rates or are preparing to reduce them soon. The growing interest rate spread between US rates and foreign governments can lead to appreciation of the dollar, which tends to hurt domestic exports. The president has been vocal on Twitter, voicing his concern for the Fed’s policy thus far. He has even made calls for the Fed to drop interest rates to zero – or even negative territory – to match those seen in Europe and Japan.
What should we expect out of the FOMC meeting this week?
According to CME group, the probability of the Fed lowering rates by 25 basis points had been fluctuating around 66%, with the other 34% chance of the Fed holding rates steady. That probability has increased to over 70% as we near the announcement.
Wall Street has been pricing in a 25 basis-point cut since the last FOMC meeting. In recent meetings, the Fed seems to be sticking to market predictions. The expectation that this will continue was supported by Jerome Powell repeating once again that the Fed will act as appropriate to maintain the expansion. To stay up to date with the latest news on the Fed and interest rates, stay tuned to our Insights page. If you need assurance that you are getting the most competitive rates on your deposits, even in a declining interest rate environment, talk to ADM about our Deposit Management services.