The Fed’s 2019 Playbook

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The Fed’s 2019 Playbook

With the Federal Open Market Committee meeting this Wednesday, let’s take a look at what Fed Funds Futures think about future US central bank policy (all prices as of 330pm Monday):

June 19 meeting

  • 83% chance the Fed keeps rates at 2.25% – 2.50%
  • 17% chance of a 25 basis point rate cut

Takeaway: no rate cut this week.

July 31 meeting

  • 71% chance of a 25 basis point cut
  • 15% chance of either a 50 bp cut or another 25 bp after a June cut
  • 14% chance that rates are the same as today

Takeaway: market all but certain (86% odds) of a rate being lower than today here.

September 18 meeting

  • 53% chance the Fed has cut by 50 bp from today
  • 33% chance the Fed has cut by 25 bp from today
  • 10% chance the Fed has cut by 75 bp from today
  • 4% chance rates are the same as today

Takeaway: market gives almost 2:1 odds (60%) the Fed will have cut twice by this meeting.

October 30 meeting

  • 47% chance the Fed has cut by 50 bp from today
  • 23% chance the Fed has cut by 75 bp from today
  • 25% chance the Fed has cut by 25 bp from today
  • 2% – 3% chance (each) that the Fed has either not cut at all or by 100 bp from today

Takeaway: after 2 rate cuts in 2019, the Fed likely pauses here.

December 11 meeting

  • 35% chance the Fed has cut by 75 bp from today
  • 35% chance the Fed has cut by 50 bp from today
  • 13% chance the Fed has cut by 100 bp from today
  • 14% chance the Fed has cut by 25 bp from today
  • 1% – 2% chance (each) that the Fed has either not cut at all or by 125 bp from today

Takeaway: another rate cut here (on top of the first 2) is basically a 50:50 shot.

January, March and April 2020 meetings

  • 32% – 35% chance the Fed has cut by 75 bp from today
  • 22% – 28% chance the Fed has cut by 50 bp from today
  • 21% – 25% chance the Fed has cut by 100 bp from today

Takeaway: after 3 (most likely) or 2 cuts in 2019, the Fed stands pat in Q1 2020.

Three points on this data:

#1: Fed Funds Futures markets clearly expect a sequence of rate cuts, not just a one-and-done approach. This implies the US economy will see a measurable slowdown in activity throughout the second half of 2019. The Fed may pause in October, but with no November meeting they could see the need to cut again in December.

#2: These steps will be enough to stabilize the US economy by the end of 2019. Fed Funds Futures for Q1 2020 don’t look much different in terms of the modal (most likely) estimate of 1.50% – 1.75% from the December contracts.

#3: This explains why US equity markets are less perturbed by the need for Fed action than one might think prudent. The S&P 500 is just 1.8% away from its all time high, after all, and trading for 16.5x earnings – spot on its 5-year average. The market’s default assumption is that 2H earnings may be dented by an economic slowdown, but lower interest rates will support valuations and 2020 will look better.

Final thought: as comforting as this scenario may be, it still carries risks.First, the Fed may not deliver on the 2-3 cuts the market expects. Second, stocks will have to hold their courage when the bad news that makes those cuts necessary comes to fruition. Lastly, Fed Funds are not the only source of uncertainty – the Trump/Xi meeting at the G20 summit is next week, for example. Barring a breakthrough there, which looks less likely by the day, we remain cautious on the near term outlook for US stocks.

Source: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html