The Fed Next Steps: What’s Likely, What’s Not

At its last meeting, the Federal Reserve gave a pretty clear signal that they don’t intend to cut interest rates in December.

They’ve cut rates three times in a row now, for a total of 75 basis points. And their perspective is that those rate cuts have done enough to provide insurance against the negative risks in the global economy. We do, however, continue to expect rate cuts over the course of 2020, largely because our economic view is more negative than that of the Fed or even that of the market. Because of that view, we think the Fed has not yet done enough to protect the economy against headwinds, and we expect two or three more rate cuts over the course of next year. The good news is we think that in time those rate cuts will be effective and will stabilize growth. We don’t forecast the US recession. We don’t expect growth to turn negative, but we do think it’s going to take additional monetary policy easing to get to that outcome. The Fed’s perspective here and the way that they act going forward, we think, will be colored by the experience of the last recession. We think that their desire to avoid the worst outcome, their desire to avoid having to go back to quantitative easing, into other previously unconventional monetary policy tools, gives them a lot of incentive to act preemptively, to take out more insurance than they think is necessary, to move faster, to move harder. To a degree, they already have. Remember, we’re talking about a committee that has already cut interest rates 75 basis points with the unemployment rate at a historically low level. But we think that that need for preemption—that incentive for preemption—is still going to be pretty strong and will lead them to cut rates again, even if the economy continues to expand, because they want to avoid the sort of problems that we had in the past cycle. The best way to avoid having to get to quantitative easing is to boost the economy earlier rather than later. And we think that they will move in that direction. Around any forecast there are risks, and the risks are always two sided. So we could be wrong here in either direction. If we’re wrong and the economy performs better than we expect, then the Fed probably will not cut rates any further. The good news from a market perspective is that Chair Powell was explicit in his press conference following the last meeting that they’re not anywhere near contemplating rate hikes either. So you can paint a very favorable scenario for markets wherein the economy begins to accelerate again and the Fed stays on hold. We don’t think that that is a very likely outcome, because even if the trade tensions start to abate, what we see is a period of muddling through rather than a true acceleration. That is the upside risk. On the downside case—which frankly to us seems more likely in that, if we are wrong, it’s more likely things will be worse than we expect rather than better—the Fed may have to cut rates back down to zero, which they won’t hesitate to do if necessary. And, once at zero, if they need to continue to provide accommodation to the economy, we don’t have any doubt at all that they will go back and resume quantitative easing if necessary. That is now conventional monetary policy. And if we land at the zero bound again, we should absolutely expect the Fed to resume large-scale asset purchases. We should expect the Fed to provide forward guidance, telling us how long they expect rates to be very low for. The one thing that we don’t expect to see, however, is negative interest rates. It’s a topic that the market has discussed quite a lot. And the Fed has been very explicit that they don’t look favorably on negative interest rates. And it’s the kind of thing that they would only consider after exhausting all the other tools available to them. So we think that recent market discussion and market worries about negative interest rates are overblown at this stage. Related: Earnings Growth Is King in a Post-Cycle World