News & Analysis

Federal Reserve Again Changes Course, Rate Cuts Likely

The Federal Reserve has seemingly changed its position on interest rates yet again, thus further demonstrating a disturbing lack of policymaking cohesion under Federal Reserve Chairman Jerome Powell.

First, in December 2018, Powell said that the balance sheet wind down was on “autopilot,” meaning that there were no signs of the Fed changing their policy of quantitative tightening, or the large-scale selloff of treasury bonds and other financial securities on the Fed’s asset books. Then, the Federal Open Market Committee (FOMC), the Fed’s decision making body, stood by its target range of 2.25 to 2.5 percent for the Federal funds rate due to “sustained [economic] expansion, strong labor market conditions, and inflation near the Committee’s 2 percent objective.” Yet now, Federal Reserve officials are reportedly considering a rate cut as soon as their upcoming June 18 and 19 meeting.

While the Federal Reserve, especially under Powell, has attempted to outlast critics of its quantitative tightening policies, it seems that President Trump, one of the Fed’s most outspoken critics, and the rest of the pro-rate cut day traders and politicians alike have won out. However, one could argue that Powell and the Fed aren’t merely bending down to disgruntlement, but, rather, are answering the calls of the free market. Newly released economic data in the labor and bond markets raise two massive red flags and prove that the Fed is in desperate need of a shift in opinion and policy.  

May labor market statistics were abysmal, to say the least. Companies added just 27,000 new jobs, a number that was over 150,000 short of the Dow Jones estimate. The worst data, however, came from companies with fewer than 50 employees (i.e. small businesses), which reported a loss of 52,000 jobs. Interestingly, this slowdown follows a tremendously positive April report that saw over 250,000 jobs added to the market, almost 10 times the amount in May. The bond market is also showing signs that economic growth and investor confidence are drastically slowing down. One of the most important factors in the bond market is the difference between the yields of 10-year and 3-month treasury bills. Some experts conclude that when the yield curves “inverts,” or the 10-year rate is lower than the 3-month, that a recession is in the horizon. Data from the Federal Reserve of St. Louis shows the long term history of rate inversions and their close association with economic downturns, which began in 1990, 2001, and 2007.

While there is open disagreement on the previous point, Federal Reserve Vice Chairman Richard Clarida seems to agree. “I do think you have to look at the yield curve,” he said. “I think historically a flat yield curve doesn’t convey a lot of information. If the yield curve inverts as it has … and if it persists for some time, that’s obviously something I would definitely take seriously.”

One way to reassure investors during an inverted yield “crisis” is cutting rates, which serves to increase long-term confidence and security in our financial system.

Federal-funds futures imply that markets anticipate with near certainty that the Federal Reserve will indeed issue at least one rate cut this year:

However, one traditional rate cut of 25 basis points may not be enough. Fed funds futures contracts are showing the need for, or at the very least, a high likelihood, of a total cut over 50 basis points off the current effective rate:

The FOMC meets first on June 18 and 19 to decide if it will adjust the Federal funds rate, and will not meet again until its next session on July 30 and 31. Until then, a potential trade war with China and the ongoing Brexit crisis contribute greatly to the uncertainty weighing on investors’ and employers’ minds. The only certainty there seems to be of a Fed rates intervention, but the question still remains: when, and how much?

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