Fed Lowers Rates for First Time Since 2008

In one of the most anticipated meeting outcomes in recent memory, the Federal Reserve lowered the Federal Funds rate today by 25 basis points (bps) to 2.00% - 2.25% and left the door open for further cuts this year. This is the first move lower in the Fed Funds rate since December 2008, when we were in the midst of the global financial crisis and comes only seven months after the last Fed hike in December 2018.

In conjunction with the rate cut, the Fed also announced an early end to its balance sheet unwind, acknowledging the need for further easing of financial conditions.

All but two of the 10 voting members voted in favor of the rate cut, with the two dissenters, Ester George (Kansas City) and Eric Rosengren (Boston), preferring no move.

Citing muted inflation pressures and “the implications of global developments for the economic outlook,” the Fed acknowledged uncertainty and therefore the need to lower rates. They will “continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”

Language Changes and Themes

  • The labor market remains strong and economic activity has been rising at a moderate rate.
  • The FOMC acknowledged that growth of household spending has picked up while business fixed investment has been soft.
  • Inflation remains low and longer-term inflation expectations are little changed.
  • The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated.

Conclusion

The question going forward is whether this move, and possibly a second 25 bp cut in September, is the beginning of a prolonged easing cycle or just an "insurance" move to ensure the economy remains on stable footing. While the market is pricing in a more aggressive Fed, LIM’s base case calls for only one or two near-term cuts as it is our view that the economy remains in decent shape and that growth will rebound closer to trend in the second half of the year. The consumer, the main driver of the U.S. economy, continues to remain healthy, supported by a strong labor market, and easing financial conditions. The one weak spot has been from the manufacturing sector with business confidence remaining shaky as the trade war remains unresolved and the dollar continues to strengthen. If trade tensions continue to drag on and business investment remains weak, the economy may need more stimulus than we currently project.

Fundamentals:

  • The U.S. consumer remains resilient, benefiting from strong employment and easy financial conditions.
  • Corporate America remains cautious with ongoing trade tensions keeping business spending on hold.
  • Fiscal policy options are limited due to the ballooning deficit.
  • Global growth continues to weaken with global central banks tilting toward dovish policy.

Technical forces, as listed below, continue to be very influential on the rate markets.

  • $13 trillion in negative yields globally have pushed overseas investors to the U.S. markets
  • Political influence: trade policy uncertainties
  • Global central banks remain accommodative
  • Global conflict/tensions on the rise

Continuing to complicate the Fed’s course of action is the protracted uncertainty surrounding the trade war with China (and others), as well as unprecedented political pressure from the White House. We would expect the economy to remain at trend growth and the Fed to disappoint market expectations with less monetary stimulus should a near-term resolution to the tariff uncertainty emerge.

If you have questions on the market impact as these events unfold, please reach out to us directly. We would be happy to discuss our views.

Disclosure
The opinions contained herein are those of Longfellow Investment Management Co., LLC (LIM) at time of publication and may vary as market conditions change. They are based on information obtained by LIM from sources deemed to be accurate and reliable. However, accuracy is not guaranteed. It is in the sole discretion of the reader whether to rely upon the opinions contained herein. The information provided does not constitute investment advice, is not a recommendation, offer or solicitation to buy or sell any securities, or to adopt any investment strategy and should not be relied upon as such. It does not take into account an individual investor’s particular investment objectives, strategies, tax status or investment horizon. There is no guarantee that any forecasts contained herein will come to pass. Past performance is not an indication of future results. Investment involves the possible loss of principal.