Gradual deterioration of consumer and corporate confidence as an aftermath of the trade standoff becomes the central theme of the Fed’s argument in favour of fresh round of monetary stimulus, for the first time in a decade.
It became clear from yesterday’s Powell’s speech that macroeconomic data should be temporarily sidelined (as can be concluded from Powell’s quite restrained acknowledgement of the spike in June payrolls) and the policy becomes focused on managing expectations, or more precisely curbing pessimism in response to the trade war developments. The Fed turns its attention completely to leading indicators, thus recognising that monetary decisions will be proactive.
The key points of yesterday’s Powell’s speech in Congress, which almost predetermined the outcome of the July meeting (a rate cut), were the following:
“Many Fed officials saw stronger rate-cut case amid rising risks”
“Many judged additional monetary policy accommodation would be warranted in the near term should these recent developments prove to be sustained and continue to weigh on the economic outlook”
The major risk is possible slowdown of the US economy due to sharp reversal in US manufacturing activity (plunge in production PMIs), decline in inflation expectations, contraction of hiring, investment plans and producer prices as a response to trade tensions.
Powell downplayed the importance of strong June Payrolls (+ 272K) and stated that he sees no signs of overheating in the market. He once again emphasised the absence of connection between inflation and unemployment within the Phillips curve (“faint heartbeat in the relationship between inflation and unemployment”), i.e. the factor of declining unemployment has lost its previous importance in determining monetary policy.
Increased employment and a generally healthy wage growth rate have led markets to revise the odds of the “big rate cut” by 50 bp. However, the Powell’s speech, riddled with pessimism, brought this case back on the table. According to federal funds rate futures, the odds rose from 0% to 27.3% after Powell speech and Minutes release.
The dollar is likely to continue to decline against other major currencies exactly due to “room for rumors” about the case for 50 bp cut, as Powell obviously gave a green light for that.
Responding to the question about whether he could “pack up and leave,” if the president demands, Powell said that he intends to serve in the 4-year period provided for by the law. Trump’s role in forcing the Fed to lower rates remains questionable, although there is obviously indirect influence, and this is actually tariffs, as well as unpredictable threats to rise stakes the trade conflict with China, as well as opening of new trade war fronts (for example, with India).