Issue 103: Fed Easing Begins!

This Week’s Highlights

• Fed goes big with 50 bps initial cut
  The wait is over, and the FOMC didn’t disappoint, putting in a half-point cut at its Wednesday meeting, and signaling another 50 bps of easing through the end of 2024. From the official statement and Powell’s press conference, the Fed appears confident in a soft landing.
• BoE, BoJ elect to hold rates steady
  While the Fed was kicking off its easing cycle, central banks to the east and west paused; the BoE saw solid growth not requiring further intervention, while a stronger yen gave the BoJ room to wait on further hikes, supporting what has sometimes seemed a fragile recovery.
• Jobless claims fall short of forecasts
  Despite the data reflecting a holiday-shortened week, investors were happy to see Thursday’s report on initial jobless claims come in under analysts’ forecasts, supporting the Fed’s story that US labor is robust, and its 50-bps cut wasn’t out of undue anxiety over jobs.

The CIO’s Take:

• Although we believed that the Fed’s confidence it isn’t behind the curve would lead it to a more conservative 25-bps cut, at least Powell didn’t disappoint the market. In our minds, the Fed’s move affirm a soft landing as our base case, and we see two cuts in the next two meetings, plus or minus one, depending on how the data evolve. The biggest risk still seems to us a resurgence of inflation.
• Neither the BoE or BoJ decisions struck us as surprising, and it’s really the guidance investors should be tracking. In the case of the UK, solid growth makes the MPC’s lack of urgency to cut again prudent, in our view. As we expected, the BoJ is also in no hurry to hike, which investors should take as a short-run positive sign for Japanese shares.
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  We’re not putting too much weight on a single weekly bit of jobs data, though one takeaway from the market’s bullish reaction to close the week is that we’re back in a “bad news is bad news” situation, where markets will be looking for validation of the Fed’s policy approach, and things could get very ugly if the macro data miss.

Fed Easing Begins!

Cycle starts with 50-bps cut
Last week finally brought the Fed pivot investors have been waiting for since the end of 2023, and it arrived with a bang: a half-point cut to the Fed’s policy rate, its first reduction since initiating rate hikes back in March 2022, bringing the target range to 4.75–5%. Going into last Wednesday’s announcement, the September FOMC meeting was characterized by an unusual degree of uncertainty as observers debated the size of a cut, reflecting how much more balanced the risks of unemployment and inflation have become in recent months.

Many expected a smaller move
In fact, we were in the camp expecting a quarter-point cut, and we weren’t alone: 105 of 114 economists polled by Bloomberg ahead of the meeting expected the Fed to go with a 25-bps first move. What was our rationale? As recently as June, the FOMC predicted only a single rate cut through the rest of this year. Of course, that was before a surprisingly weak jobs report in July, though we saw August’s uptick in core inflation, along with robust retail sales and industrial production contributing to make a “jumbo” rate cut less likely to kick off the easing cycle.

Big shift in balance of risks
So, what does the supersized cut—rare to begin a sequence of rate cuts outside some major shock to the economy—tell us about the Fed’s current state of mind? We see it as a preemptive move by a central bank which sees the balance of risks shifting very significantly from inflation to unemployment. Indeed, that change is immediately visible in an assessment of FOMC participants’ risk perceptions pulled from this month’s quarterly Summary of Economic Projections, in which fears of upside risk to unemployment suddenly dwarf those of upside risks to inflation (see below).

FOMC statement shifts, too
The Fed’s official statement emphasized the shift in risks, with job gains described as having “slowed” (in the July statement, they had simply “moderated”), and the phrase “supporting maximum employment” inserted as a goal to which the Committee “is strongly committed”, alongside “returning inflation to its 2 percent objective”—in which the Committee stated it had “gained greater confidence” since July. Interestingly, the statement revealed one dissenting vote: Governor Michelle Bowman, who preferred easing by only 25 bps: the first dissenting vote at an FOMC since 2005.

Clues from Powell’s presser
Not surprisingly, much attention was on chairman Powell’s press conference, as investors wondered whether the 50-bps move might signal concern on the Fed’s part over a hard landing. To the contrary, Powell said explicitly that he does not believe the Fed is far behind the curve. Rather, the Fed sees itself in a place where inflation is coming down comfortably and employment—though still strong—is softening meaningfully. Because the Fed believes the labor market is no longer driving inflation, the more prudent play was to front-load easing and get ahead of weakening jobs.

50 bps shouldn’t set the pace
In our view, one of Powell’s chief objectives in the presser was to talk the market off of expectations that the pace of easing will now be 50 bps/meeting. He emphasized the Fed didn’t have a “pre-set course”, and that the size of future cuts would be determined “meeting by meeting”. That’s something we see in the revised dot plots, too, with the Fed penciling in a median two more cuts this year—though we note that there’s a big mass of dots anticipating just one additional move. Predictably, the market jumped out to expectations of three more cuts in the remaining two meetings.

Good news mostly priced in
Markets didn’t put in much of a reaction on Wednesday, with the dollar initially plunging, 2-year Treasury yields falling, and stocks rallying in choppy trading through Powell’s press conference, after which Treasury yields rebounded, the dollar pared its losses, and stocks retreated into the close. As traders digested Powell’s remarks, they likely concluded the future path of easing will depend a lot on the data—pretty much the situation we were in before the FOMC—so with a 50-bps cut confirming what was priced in ahead of the meeting, there’s little more to do than wait.

Were there politics at play?
Given a US presidential election is less than two months away—just days ahead of the next FOMC—this month’s Fed meeting took on a political dimension, with Democrats predictably cheering the half-point cut and Republicans just as predictably accusing the Fed of bias while pointing to anything negative in the data: fears the Fed fell behind the curve, labor market weakening, and sticky inflation. That last point, in our view, has the most merit, with a resurgence of core inflation representing the biggest threat, as we see it, to a smooth sequence of cuts heading into 2025.

BoE, BoJ Sit Tight

UK and Japan policy rates on hold
Last week’s monetary meetings weren’t restricted to the US. On the other sides of the Atlantic and Pacific, two important policy conclaves also took place, with the Bank of England (BoE) and Bank of Japan (BoJ) deciding on their next moves with respect to rates. In each case, the outcome was a hold, though the banks appear to be on very different trajectories (see below), with the BoE pausing after August’s quarter-point cut, and the BoJ standing pat after a surprise rate hike in July.

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Markets expected BoE pause
The BoE’s prior cut, in August, was its first reduction of policy rates in over four years. Just as with the Fed’s September decision, there was a single holdout on the BoE’s Monetary Policy Committee (MPC), with one of nine votes urging a second consecutive quarter-point cut, though the majority moved to keep rates steady, in line with traders’ consensus going into the meeting. The MPC decided not to alter the pace of balance sheet reductions, defying the expectation of a number of observers—ourselves included—that policymakers might modestly accelerate their QT program.

BoJ shows no urgency to hike
Meanwhile, in Japan, policymakers signaled patience with economic progress and no desire to hurry hikes, as policy is already tighter than at any time since 2008. In part, the BoJ was able to hold off because recent yen strengthening takes a bit of pressure off prices, though Governor Ueda also cited “some weakness” in the nation’s economic recovery. Overall, however, the bank seems happy with conditions, especially as they relate to domestic demand, with the BoJ’s September statement revising private consumption from “resilient” to being on a “moderate increasing trend”.

FX reacts to banks’ policy paths
Naturally, with so many policy moves by central banks around the world, it’s hard to disentangle how much of the markets’ reactions we should attribute to any one action. Traders seemed pleased with the BoE’s guidance on a likely rate cut in November, pricing that as something of a foregone conclusion, with the likelihood of a cut at the December meeting rising to around 75%. The pound strengthened by 0.8% against the dollar last week after the BoE hold, helped by strong retail sales, while the BoJ’s patience on hikes sent the yen down against the dollar and the Nikkei up.​​​​

Data on Jobs

Happy surprise in jobless claims
Investors didn’t have to wait long after the Fed’s Wednesday decision for data to help them handicap the central bank’s next move, with a report from the US Labor Department on Thursday offering a window into job market conditions. That’s obviously important, considering the FOMC’s telegraphing unemployment as its new focus and investors’ concern they may already have fallen behind in addressing a softening labor market. In a positive sign, initial jobless claims fell by 12K from the prior week, landing at 219K, well below market expectations of 230K—a four-month low.

Indeed: US salaries also growing
It’s just one data point, but we see it as supporting our view that although the labor market is clearly weakening, it was in a pretty good place when the softening started, and—at least so far—remarkably resilient. August data from jobs site Indeed.com tell a similar story (see below), with salaries in job postings rising for the fourth month in a row, growing 3.4% year-over-year. That’s a far cry from the massive wage growth witnessed amidst extremely tight labor supply during the pandemic, but a positive sign, nonetheless, as we enter an easing cycle.

Labor market becomes a focus
It’s worth a word of caution that the Labor Day holiday likely depressed unemployment claims, so there could be a bounce back. That said, Powell was clear at the end of his Wednesday press conference that he doesn’t see a recession, and solid numbers on the labor market will serve to reinforce a view that the soft landing is in sight. In the months ahead, markets will be looking for evidence to support that and we expect investors to be especially sensitive to any data that calls this narrative into question.