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Three Times A Charm? Rate Cut Comes As No Surprise, But Pause May Be Ahead

Key Takeaways:

  • Fed cuts rates 25 basis points, as most analysts had expected
  • It’s the first time in 11 years that three cuts occurred in three meetings
  • Fed cites strong labor market, but weak business investment climate

If you wanted a trick, you’ll have to wait until tomorrow because the Fed didn’t have any up its sleeves today.

Instead, the Fed delivered the “treat” most analysts had expected going into this week’s meeting, cutting the Fed funds rate by 25 basis points back to the lowest level in more than a year at between 1.5% and 1.75%. It was the third rate cut since July.

The Fed also implied that it might take a pause before any next steps. At least that’s the impression from changes in the language of its statement. The Federal Open Market Committee (FOMC) removed language it had used since June saying that it was committed to “act as appropriate to sustain the expansion.”

Remember that word, “act.” Because it’s not there anymore.

That language got changed to, “The Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate.”

“We believe monetary policy is in a good place,” Fed Chair Jerome Powell told reporters after the FOMC meeting.

Less “Active” Fed Might Be Ahead

To some analysts, the removal of the word “act,” and what appears to be its replacement with “assess” implies a less active, hands-on policy in the months ahead. Odds of another rate cut in December now stand at 20%, according to CME Fed funds futures, down from 30% a week ago. You now have to go out to the FOMC’s April meeting to get to 50% or greater odds of another cut.

The Fed observed that today’s cut was due to “global developments” and “muted inflationary pressure,” and also noted strong consumer spending and a strong labor market, but also pointed out that business fixed investments and exports “remain weak.”

The Fed’s outlook is for a continuation of current conditions, with inflation coming back toward the Fed’s 2% goal, strength in the labor market continuing, and moderate economic growth.

Only two FOMC members voted against the rate cut today, down from three last time. Two voted for no change to rates, while St. Louis Fed President James Bullard, who’d wanted a 50-basis point cut last month, voted in favor of the 25 basis-point cut today, which got rates down to where he’d wanted them in September.

The Fed began cutting rates three months ago in what it’s said is an effort to keep the economic recovery humming along in the face of weakening business sentiment, a long-running trade war with China, and slowing economies both at home and overseas.

In the moments after the rate cut, stocks didn’t really make major moves. Instead, the major indices stayed near unchanged, but small-caps continued to take a beating. Treasury note yields are slightly lower, with the 10-year yield back down to 1.8%, off of highs near 1.85% earlier this week. Some analysts see 1.8% as a technical support level, so we’ll see if the yield can stay above that.

At least in the first half hour after the Fed’s move, the market doesn’t seem too concerned about the new Fed language, at least in the early going. The idea that the Fed will be a “backstop”—in other words ready to lower rates if the economy takes another hit—hasn’t gone away, as one analyst pointed out on CNBC. That might be buttressed by language from Powell himself.

“If developments emerge that cause a material reassessment of our outlook, we’d respond accordingly,” Powell said. “Policy isn’t on a pre-set course.”

Also, the market seems to be thinking rate cuts could ultimately help the economy, based on the fact that Treasury yields have generally been heading up and cyclical stocks have outperformed defensive ones over the last month. Those are often signs of investor optimism.

What Happens Now?

This is the third occasion in four months that the Fed has cut rates, and marks the first time since 2007-2008 that we’ve been on a steadily lower path. That 2007-2008 cycle was a long, steep one that took rates down from a high of 5.25% in September 2007 down to essentially zero by December 2008 as the recession tightened.

Back in 2007 when the Fed started that set of cuts, gross domestic product (GDP) growth was similar to now at around 2%, but unemployment was 6%. Now the jobless rate is just 3.5%, leading some economists to wonder if more cuts are justified.

Fed officials, including Powell, have made it clear that rates aren’t on a pre-ordained path. A number of Fed speakers have also said lately they aren’t sure if further cuts are needed anytime soon. The markets have dimmed the outlook for more accommodation beyond today, and chances for another easing this year have fallen well below 50-50.

However, recent economic data have continued to look a bit sluggish, and inflation remains pretty much a non-factor. Even though today’s first government estimate for Q3 GDP growth came in above Wall Street’s expectations at 1.9%, that isn’t a number that’s likely to raise concerns about the economy running too hot. All this could give the Fed room to cut more if it wants to either in December or early next year,

Some analysts argue that the Fed might want to keep some firepower unused in case it’s needed later. The lower rates go, the less ability the Fed has to counter a recession by making borrowing cheaper. When rates went to zero in 2008, the Fed had to take some extraordinary steps to stimulate the economy, notably quantitative easing (QE), where it bought government bonds and ran up a massive balance sheet.

Other governments have taken rates to negative levels, but the jury is still out on the effectiveness of those. Fed officials have pretty much dismissed that idea, with Powell telling reporters after the last FOMC meeting, “I do not think we’d be looking at using negative rates,”

It’s also possible that before taking rates down from current levels, Fed officials might want more time to see how lower rates play out—maybe a few months. It typically takes time for them to work their way through the economy.

In his press conference, Powell said risks to the economy remain trade policy developments, slowing global growth, and muted inflation. He believes the signing of a Phase One trade agreement with China—if that happens— has a chance to raise business confidence and maybe business activity, too. The Brexit risk seems to have subsided a little recently, he added.

Despite all the hoopla this week around the Fed, Apple (AAPL) earnings, payrolls, the cancellation of a summit where U.S. and Chinese leaders had planned to meet, and GDP, the market’s been behaving pretty well (it might help that the meeting cancellation had nothing to do with any trade-related factors, but instead reflected domestic unrest in Chile, where the meeting next month was intended to be held).

It is actually impressive that we have held these gains above 3000 in the S&P 500 (SPX), even if we are down slightly from the all-time highs reached earlier this week. Considering what is going on, it’s good that there hasn’t been any hard sell-off pressure. The encouraging thing is, we are trading more on what you should be trading on, mainly earnings, and less on rumor and innuendo. That’s a nice change of pace and how the market arguably should work.

Will Shot of Stimulus Help Tepid GDP? Some economists wonder if lower rates can do much to stimulate the economy at this point. Except for a brief jump above 3% a year ago, the benchmark 10-year Treasury yield has been historically low basically for years. Looking at the recent GDP data, it’s easy to conclude that low borrowing costs aren’t leading to great things for the economy.

Some blame the GDP softness on higher rates that the Fed had in place a year ago, but others say the trade war and slowing European and Asian economies might play a bigger role in tepid U.S. GDP growth. The trade issue has lasted a couple years now and seems to have taken some zip out of business confidence. Even an agreement in the near-term might not be enough to immediately nurse business sentiment back to full health (see more below). So far, lower rates haven’t appeared to help, either, but maybe they can help as they eventually filter through the economy. Seventy-five basis points since July isn’t incredibly dramatic, but it’s not nothing, either.

Confidence Check:  Even if the leaders of China and the U.S. announce trade progress sometime soon (they were supposed to meet in Chile Nov. 17, but that meeting got abruptly canceled by Chile earlier today), it doesn’t necessarily mean U.S. big business can breathe easy. Business confidence has been sapped by this long trade war, judging by what we’re hearing from some of the earnings conference calls this time around. That isn’t something that just gets back to normal thanks to a couple of signatures.

If there’s a trade deal, we may see an initial lift for the market, but it’s not necessarily the case that business spending will start up again quickly. As Reuters reported earlier this week, companies such as Caterpillar (CAT), 3M (MMM), and Texas Instruments (TXN) have blamed the protracted trade dispute for undermining their revenue or profits as well as their financial outlooks. That said, the number of S&P 500 companies that have mentioned the term “tariff” so far this earnings season (as of last Friday) is 59, down slightly from 66 over a comparable period in Q2 reporting season, according to data from FactSet.

Balance Reminder: You’ll often hear financial experts tell investors to make sure they check their allocations among different stock sectors and find the right balance between cash, fixed income, and stocks. Another thing you might hear is that if you decide to buy an individual stock, be careful about putting too many eggs in one basket. Some people are tempted to do this, especially when their 401-K plan offers their company’s own stock as an investment choice.

Anyone watching the major networks Tuesday morning got another lesson about all this as Boeing (BA) CEO Dennis Muilenburg sat in the hot seat in front of TV cameras and angry senators fielding questions about the 737-MAX. Some of the senators gave Muilenburg a grilling, and it started to look like other recent hearings featuring CEOs from some of the FAANG companies like Facebook (FB). BA’s stock held up pretty well through the ordeal on Tuesday, but it’s down 21% from its 2019 high. While it’s certainly possible that BA could fix its issues and the stock could come back, the last seven months arguably help show what those experts meant when they talked about keeping your portfolio balanced.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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