Overview
'Mid-cycle adjustment’
‘Insurance’ cuts were successful in 1995-96, when the Fed implemented three cuts within seven months, taking rates from 6 per cent to 5.25 per cent, and managed to extend the economic upcycle by another six years to early 2001.
At the press conference, Chairman Jerome Powell said that Wednesday's cut should be seen along the lines of previous ‘mid-cycle’ adjustments. In answers to questions around further rate reductions over the next couple of months, Powell walked a fine line between not guaranteeing the market further cuts, but not ruling them out either. When asked whether one cut would be enough, he stressed that today’s move should be seen in the context of the gradual adjustments made to the assessment of the appropriate policy rate path year to date. When asked, multiple times, how many more cuts the Fed was contemplating, his only answer was that the Fed will be data-dependent.
However, the Fed’s press release contained a specific reference to ‘the timing and size of future rate adjustments’, with the reference to ‘size’ indicating that a larger than 25bps adjustment remains a potential next step.
Overall, the Fed appeared to be struggling somewhat to get the balance right. But it nevertheless looks likely that, unless economic data improves significantly during the next couple of months, a further cut will be implemented later this year, similar perhaps to what happened in 1995-96. Thereafter, assuming that the cuts have at least some of the desired effects and inflation expectations move closer to the targeted range, we would expect the Fed to be very reluctant to use more firepower before the next real recession hits.
Source: Refinitiv. July 2019
Balance sheet reduction ends two months early
The Fed also announced that, having shrunk its balance sheet by approximately $650 billion since October 2017, it will halt its balance sheet reduction program in August, two months earlier than planned. This adjustment should not come as a surprise given the easing move implemented on Wednesday, and the practical implications are limited to a delta of 1.5 per cent on the overall size of the balance sheet.
