The U.S. Federal Reserve’s Federal Open Market Committee (FOMC) meets next week. The result will be a refreshed monetary policy statement and quarterly economic projections. With regards to the economic outlook, I expect the Fed’s forecast for the Fed funds rate may disappoint against investor expectations. However, I also expect a dovish pivot for the Federal Reserve could suffice the market.
Market Expectations for the Federal Reserve
The U.S. Federal Reserve’s FOMC meets next week and publishes its monetary policy statement at 2:00 PM EDT on Wednesday June 19, 2019. As of Friday June 14, 2019, the CME Group’s FedWatch Tool indicated market expectations for no Fed rate action at this June meeting. Therefore, no rate action by the Fed next week should not be a disappointing result for investors.
However, looking ahead to July shows that investors see a 64% probability of a quarter-point Fed funds rate reduction. By September, the market expects (at a 56.6% probability) the Fed to cut rates by 50 basis points or a half of a percentage point. By the close of the year at the December meeting, the market anticipates (39.1% probability) the Fed funds rate will be 75 basis points lower. That would take three quarter-point cuts if broken out evenly. So how do these market expectations compare to the Fed forecast?
Fed Economic Forecasts
At its publishing of its economic forecasts in March, the Federal Reserve projected a median Fed funds rate of 2.4% by year-end 2019, which is about unchanged from the current target range. The March meeting marked a Fed pivot to neutral from hawkish. However, the market has moved beyond neutral with its expectations for this year at this point. Reiterating, the market sees more than a 50% chance of a Fed funds rate that is at least a half point lower by year-end, and its best guess is for a 75 basis point lower Fed funds rate by the December meeting.
Economic Outlook is Less Certain
That marks a significant divergence from the Fed’s now outdated forecasts. Since those forecasts were published, the trade war with China has taken an ugly turn that has investors worried about its potential implications for the economy. CNBC’s real-time survey of economists’ expectations shows a general outlook for slower growth in Q2 and Q3 than seen in the first quarter of the year. And some recent data, like that seen in the Employment Situation Report for May and the ISM Manufacturing Report were less than reassuring.
Job growth slowed in May and the ISM data deteriorated, though it continued to reflect economic expansion. I want to be clear, though, to note that U.S. economic data has not been distressing or concerning. It’s the outlook that is concerning, mainly because of the escalation of the trade war between the U.S. and China and recent U.S. policy to use trade tactics to gain other concessions from both foe and ally alike. The market’s concern can be most clearly seen in the treasury yield curve, which has been flirting with inversion off and on. Furthermore, global growth is slowing, partly because of the trade war, according to the International Monetary Fund (IMF).
Lack of Inflation is Accommodative
The inflation situation is not at all constraining to a shift to Fed dovishness, as indicated by the most recent Consumer Price Index (CPI) data for May. Just measured Core CPI, which excludes volatile changes in food and energy prices, rose just 0.1% month-to-month in May and 2.0% on a year-to-year basis, against expectations for a 2.1% year-to-year increase. If inflation were running hotter, the Fed would be somewhat handcuffed, but without inflation running hot, and with the economic outlook in question, the Fed can consider preemptive rate cuts (preempting significant economic slowing).
What to Expect from the FOMC Meeting
While investors are not looking for a rate cut at the June meeting, they will likely note the Fed’s economic projections for the Fed funds rate. I suspect that given current economic growth, investors will amicably digest no rate action at this meeting. However, if the Fed’s economic projections do not show a pivot to dovishness, with the Fed funds rate outlook at least 25 basis points lower for the close of the year, then investors may penalize high-flying equities. The SPDR S&P 500 (SPY), SPDR Dow Jones (DIA) and Invesco QQQ Trust (QQQ) are all trading near their all-time highs.
I expect the Fed to hold the Fed funds rate steady at this meeting, but to note in its policy statement more significant risks to economic growth. I expect the Fed’s rate forecast to show expectations for a 25 to 50 basis point lower Fed funds rate by the close of the year. If this occurs, I expect the stock market to celebrate. However, if the Fed forecast shows no change to Fed funds rate expectations, then we could see stocks dip on the news. In any event, I anticipate the Chairman’s press conference following the release to be supportive to equities and to likely limit any such potential damage.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.