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For Bond Traders and the Fed, Boring Is Beautiful

Brian Chappatta
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For Bond Traders and the Fed, Boring Is Beautiful

(Bloomberg Opinion) -- I wouldn’t be surprised if Federal Reserve Chair Jerome Powell was all smiles as he watched the financial markets move in the minutes after the central bank’s interest-rate decision on Wednesday.

Heading into this week, the bond-market consensus was that the Fed would deliver its strongest “hawkish cut” yet — acquiescing once again to futures pricing but strongly suggesting that its “mid-cycle adjustment” in policy is complete. That’s exactly what happened. The Fed cut its benchmark lending rate by a quarter-point for the third time since July, to a range of 1.5% to 1.75%, and lowered the interest rate on excess reserves by the same amount, to 1.55%. In a sign of just how ready bond traders were for this move, two-year Treasury yields barely budged from about 1.625%, the precise midpoint of the new target range, in the half hour before Powell began speaking.

The most important part of the Federal Open Market Committee’s statement was that it removed the phrase that policy makers would “act as appropriate” to sustain the economic expansion. “That has been the signaling language to tip the hand that we’re moving rates; you take it out to tell the market that we’re done,” Jeffrey Rosenberg at BlackRock Inc. said. Sure enough, odds of another interest-rate cut at the central bank’s December meeting barely budged.

Powell hammered home that point in his opening statement at his press conference: “We believe monetary policy is in a good place,” he said, using a phrase he normally employs to talk about the U.S. economy, not the level of interest rates. The current stance is “likely to remain appropriate,” he said. In response to a question by Bloomberg’s Michael McKee about what it would take to ease again, he said a “material reassessment of our outlook.” As for going the other way? “We're not thinking of raising rates right now.”

This is about as close to a hard stop as could reasonably be expected from the Fed after three consecutive interest-rate cuts. And, compared with recent history, Powell appeared determined to stick to script (often literally — he read back from his opening statement during the question-and-answer portion as much as ever). That’s in contrast with his other attempts to thread the needle of easing monetary policy while sounding optimistic about the economic outlook. He seemed to just want to undo the December 2018 rate hike in July but was quick to suggest the Fed could drop rates further after hearing the stock market was tumbling. In September, sharp dissent among the ranks of the FOMC reflected an unease with back-to-back rate cuts. 

While Kansas City Fed President Esther George and Boston Fed President Eric Rosengren dissented for the third consecutive time, in favor of no rate move, there was no argument from St. Louis Fed President James Bullard for dropping the fed funds rate further. He advocated for a 50-basis-point reduction at the September meeting. Judging by the “dot plot,” which wasn’t updated this time, it seems as if Powell speaks for the entirety of the central bank in saying that interest rates are now in a good place.

“In short, a clean hawkish cut,” said Jon Hill at BMO Capital Markets. The yield curve flattened a bit, but relative to August’s inversion, the 16 basis point spread between two- and 10-year Treasuries feels like a massive buffer. That shouldn’t be especially worrisome to Fed officials. 

Powell also discussed the funding markets after the Fed’s announcement earlier this month that it would begin buying $60 billion of Treasury bills a month to keep control over short-term interest rates. As he has before, Powell emphasized that the purchases are not the same as post-crisis quantitative easing but rather a more technical move by the central bank. The Fed’s balance sheet has increased by about $200 billion since the mid-September repo meltdown, to almost $4 trillion.

As I wrote earlier this week, it seems as if the Fed is ready for a break, and it looks as if bond traders will allow it. The economic data released in the hours before the interest-rate decision affirmed the central bank’s outlook for “moderate growth.” Third-quarter real gross domestic product growth was 1.9%, beating the consensus forecast of 1.6%. If there are no revisions, growth would need to be just 1.6% in the final three months of the year to meet the Fed’s 2019 forecast for 2.2%.

None of those figures are particularly riveting, even if President Donald Trump tweeted “The Greatest Economy in American History!” But for bond traders and Fed officials alike, boring is beautiful.

As Powell said, it’s too soon to say whether the central bank has achieved the fabled “soft landing.” But short-term interest rates are now down 75 basis points in about 90 days. As he also said, that’s “a very substantial shift.” The Fed is right to let its swift actions filter through into the economy before assuming it needs to do anything more.

To contact the author of this story: Brian Chappatta at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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