Connecting the Fed’s Dots

By admin_45 in Blog

We have 3 data-oriented points about today’s Fed meeting that expand on our Markets section analysis with some longer-term thoughts:

#1: Fed Funds Futures discount another rate cut this year, but only by a narrow margin:

• October meeting contracts make the odds of a rate cut here at 45%, down from 51% a week ago.
• December contracts put 59% odds that the Fed will cut rates once more in 2019. A week ago this market was putting decent odds (27%) on two cuts by year-end. That is down to just 11% today.

Takeaway: Fed Fund Futures have really backed off the idea that the Fed will be aggressive at the last 2 meetings in 2019. We attribute that to better market sentiment over a US-China trade deal. It also gives the Fed some breathing room (for now, anyway), which explains why Chair Powell could afford to be so non-committal at this afternoon’s press conference.

#2: Futures give less than 50/50 odds on another rate cut in Q1 2020:

• March 2020 contracts price in a 21% chance rates are the same as now (1.75% - 2.00%) and 41% odds they are 25 basis points lower (i.e. that Q4 2019 cut from point #1).
• That leaves the odds of further rate cuts in Q1 2020 at 39%, heavily skewed to one 25 bp reduction (29%).

Takeaway: the data here is consistent with the idea that the Fed’s self-described “mid-cycle adjustment” will end in 2019. Maybe we’ll see one more rate cut in Q1 2020, but that’s it.

#3: A statistical analysis of the Fed’s “Dots” (individual policymaker estimates of “appropriate” future monetary policy) shows more FOMC member agreement than one might expect.

• Today’s rate decision had 3 dissenters, 2 of whom wanted a 50 bp cut and one who thought rates should stay unchanged.
• There’s also a notable dispersion of “Dots” related to rate policy over the next 90 days, with 7 implying one more 25 bp cut, 5 saying rates should stay unchanged and (remarkably) 5 thinking rates should be 25 bp higher than today’s decision.
• But look out to 2020, and the dispersion of the “Dots” is tighter than historical averages.
• The mean of the 2020 “Dots” is 1.9% with a standard deviation of 0.27. That is lower/tighter than September 2018’s “Dots” for 2019 (0.40 standard deviation), September 2017’s for 2018 (0.43), or September 2016’s for 2017 (0.44).

Takeaway: as much as the “Dots” are not really predictions, they do reflect each committee member’s macro perspective and their 2020 rate estimates show a fairly unified front.

The bottom line to all this: both Futures pricing and the Fed’s “Dots” support the idea that the ongoing cyclical “adjustment” of lower Fed Funds is actually something more permanent. We can see that by looking at something that got zero attention today: the “Dots” which show FOMC member predictions long run neutral interest rates:

• 5 years ago the FOMC's mean estimate for long run rates was 3.75%.
• A year ago, it was 3.0%.
• In Q1 2019, it was 2.8%
• In June and now: 2.6%
• Where will this be in September 2020? Our bet is “lower”…