Fed Holds Steady, but Rate Cuts Likely in the Future

Key Points

  • The Federal Reserve held its target interest rate range steady at 2.25% to 2.5%, but projections now point to a rate cut in the future.

  • The decision was not unanimous. One voter preferred that the fed funds rate range be lowered.

  • Although the median projection for the year-end 2019 points toward no rate hike, eight of the 17 FOMC participants projected a lower rate by year-end.

The Federal Open Market Committee (FOMC)—the Federal Reserve’s policymaking arm—held its target range steady on Wednesday, maintaining the 2.25% to 2.5% target range for the federal funds rate. This was widely expected by the markets.

The next move by the Fed is likely to be a rate cut, however, based on updated projections from FOMC participants.

For the first time in Fed Chair Jerome Powell’s tenure, the decision was not unanimous. Voting against the decision was James Bullard, president of the Federal Reserve Bank of St. Louis, who preferred to lower the target range by 25 basis points.

Stock prices rose and bond yields fell after the announcement. More-accommodative monetary policies can help support riskier investments like stocks, while the projections for rate cuts down the road pulled Treasury yields even lower.

Rate cuts likely

The Fed’s current “dot plot” indicates that the next move will be a rate cut. The dot plot is a chart that shows where each member of the FOMC believes the federal funds rate target should be at the end of coming years. In other words, this cycle of rate hikes is likely over.

The median projection for year-end 2019 was unchanged at 2.375% (the midpoint of the 2.25% to 2.5% target range), but a total of eight “dots” now project lower rates by year-end, with seven of those 8 projecting two cuts.

The median projection did drop in 2020, however, with the median projection falling to 2.125% from 2.625% from the March projections. In other words, the median projection for next year now indicates one rate cut as opposed to the one rate hike.

Finally, the median “longer run” projection dropped to 2.5%, a new low.

Source: Federal Reserve and Bloomberg.  FOMC Dot Plot, (DOTS), as of 6/19/2019, the Implied Fed Funds Target Rate Curve and the Overnight Index Swap (OIS).Notes: The FOMC Dots Median reflects policymakers’ expectations for interest rates. The fed funds futures rate is what investors expect the fed funds rate to be in the future. The overnight index swap (OIS) is an interest rate swap involving the overnight rate being exchanged for a fixed interest rate. An overnight index swap uses an overnight rate index, such as the overnight federal funds rate, as the underlying rate for its floating leg, while the fixed leg would be set at an assumed rate.

Economic outlook still relatively upbeat, but trade concerns pose a risk

Despite the downgraded projections to future target rate ranges, the Fed’s outlook on the economy remained relatively upbeat. The statement highlighted that the labor market remains strong, economic activity is rising, and household spending appears to have picked up. However, the statement acknowledged that business fixed investment has been soft, and market-based measures of inflation consumption have declined. At the press conference, Powell stated that crosscurrents have reemerged, including the ongoing trade concerns as well as the risk of slower global growth.

Importantly, the statement highlighted that uncertainties about the outlook have increased. The statement no longer included the language that supported a “patient” approach to policy; rather, the FOMC will “monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.”

In the Summary of Economic Projections, the projection for U.S. gross domestic product was revised higher in 2020, while projections for the unemployment rate inched modestly lower for each projected period. Meanwhile, median projections for core inflation were lowered for this year and next, in-line with declining trend in core inflation this year.

Growth projections inched up while core inflation projections dropped modestly

Source: Federal Reserve, as of 6/19/2019.

Notes: For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. The central tendency excludes the three highest and three lowest projections for each variable in each year. The range for a variable in a given year includes all participants' projections, from lowest to highest, for that variable in that year. Longer-run projections for core PCE inflation are not collected.

Market reaction

Bond yields dropped after the meeting concluded, with two-year Treasury yields experiencing the largest drop, as they tend to be very sensitive to the federal funds rate. The two-year Treasury yield dropped 12 basis points to 1.76%, its lower yield since late 2017.

Two-year Treasury yields dropped sharply

Source: Bloomberg. US Generic Govt 2 Year Yield (USGG2YR Index). Tick data as of 2:58 pm on 6/19/2019.

Ten-year Treasury yields fell to the 2.03% area, a 2.5 year low. The drop in the “longer run” projection likely helped pull long-term Treasury yields lower.

Stocks rose after the meeting, as a lower rates can support riskier investments.

Takeaways for investors

The outlook for Fed policy is now biased to the downside. While the Fed held rates steady at the June meeting, projections are now pointing to rate cuts down the road.  Although the economy continues to grow and the labor market remains strong, most inflation indicators continue to remain below the Fed’s 2% target.

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