September FOMC Meeting – another Mid-cycle adjustment
Backdrop
The Fed cut interest rates by 25bps for the second time this year, referring again to a ‘mid-cycle adjustment’.
Ahead of the meeting, markets expected the Fed to cut while leaving the door open for further easing, should the economic situation deteriorate further. Market participants began revising expectations higher from September 9th and more so after the ECB meeting. With the pace of these revisions, the Fed’s meeting is a cornerstone for the end of this year.
Markets’ expectations were met: an unchanged inflation expectation and a better growth situation in 2019 and 2020 were acknowledged by the Fed’s economic projections. Core inflation in 2019 is still expected to reach 1.8% while growth should settle at around 2.2%. However, given the importance of the external risks to this scenario, dot projections were revised in line with markets expectations. The Fed now expects that the cut could be followed by one more by the end of this year, if necessary.
The statement was very much in line with the economic projections, highlighting the still decent domestic situation and the existence of external risks (“exports have weakened”). Also, it is worth noting a growing number of dissents across Committee members, similar to the recent ECB meeting. There is, for now, little agreement regarding the need for further easing next year.
During the press conference, Jerome Powell, Chair of the Fed, asserted that the current situation was “a time of difficult judgement”, with uncertainties to some extent offsetting decent macro conditions. This mid-cycle cut could turn into further cuts, but the need for a significant worsening of the US situation is necessary for that to happen. For now, the decision may well be a step towards the end of this cut cycle.
Market Impact
The market reaction was relatively muted overall. Rates were little changed, the USD rose marginally and equity markets were the main mover on the day with the S&P 500 falling below 3,000, before closing marginally higher at 3,006.73. The initial market reaction was consistent with a lack of surprises.
During the press conference, bonds moved towards their intraday lows.
Asset Allocation Consequences
With rates edging higher since the beginning of the month, this meeting brought additional evidence of a mid-cycle pause: the Fed does not expect a recession in the near future, while acknowledging heightened geopolitical risks. Inflation is nowhere to be found for now but the Fed remains confident of future rate normalisation.
With this in mind, our current dynamic assessment articulates around three risk factors:
- Macro: growth conditions, as depicted in our proprietary Nowcasters, have stabilised above potential in the US. The overall growth situation in the US remains decent without being excellent. Inflation surprises should remain unlikely but the Fed still expects growth to stabilise. This “decent growth, limited inflation” situation is, in our view, a positive for growth-related assets.
- Market Sentiment: risk appetite has increased since the beginning of September and equities have rallied strongly on the back of it. For the moment, market positioning in equities remains low, which makes us think that it could be supportive for now. Also, the momentum seen in most growth-related assets recently is another hint that investors are likely to increase their allocations.
- Valuation: most assets have become rich as a result of central bank action and hedging assets are more expensive than growth assets in our scoring metrics. Powell’s future rhetoric will be critical here: too hawkish and it could fuel the bond selling trend that ignited recently.
This is nothing more than a mid-cycle adjustment. We currently see an alignment of planets: the macro situation is decent, sentiment is supportive while valuation is also positive for growth assets. For the moment we remain positive on growth while remaining cautious when it comes to bonds.
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