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Fed cuts rates again, telegraphs possibility of one more

The Federal Reserve on Wednesday cut interest rates again by 25 basis points to a new target range of 1.75% to 2%, and telegraphed a strong likelihood of one more rate cut by the end of the year.

Continuing to cite global concerns, the Fed said business investment “weakened” since the Fed’s last policy setting meeting in July, when it cut rates for the first time since 2008. The Fed also added new language in its statement noting that U.S. exports have also weakened, underscoring the impact of the trade war on the central bank’s reading of the U.S. economy.

Little else was changed in the statement beyond the new description of household spending as “rising at a strong pace,” reinforcing Fed Chairman Jerome Powell’s commentary over the past few months highlighting the American consumer as the driving force for a U.S. economy in a “favorable place.”

U.S. Federal Reserve Chairman Jerome Powell speaks during the "The Economic Outlook and Monetary Policy" panel discussion hosted by the Swiss Institute of International Studies at the University of Zurich in Zurich, Switzerland September 6, 2019.  REUTERS/Arnd Wiegmann
U.S. Federal Reserve Chairman Jerome Powell speaks during the "The Economic Outlook and Monetary Policy" panel discussion hosted by the Swiss Institute of International Studies at the University of Zurich in Zurich, Switzerland September 6, 2019. REUTERS/Arnd Wiegmann

But a record number of dissents under the Powell-led Fed raises questions about the uniformity of the Fed’s outlook. St. Louis Fed President James Bullard voted for a 50 basis point cut but Kansas City Fed President Esther George and Boston Fed President Eric Rosengren voted for no change to the benchmark interest rate today. Both George and Rosengren dissented against the July decision as well, also preferring at that time to hold rates steady.

Dot plots

The Fed also released a fresh print of economic projections, and lowered expectations for where rates are headed.

Seven members of the FOMC’s 17 participants see at least one more 25 basis point rate cut by the end of the year. The Fed has two more announcements scheduled this year: October 30 and December 11.

Source: Federal Reserve
Source: Federal Reserve

For comparison, in its June meeting, eight participants predicted one to two rate cuts before the new year. With the Fed now having delivered two rate cuts, policymakers appear to be acknowledging that darker developments since June have warranted a stronger reaction from the central bank than initially thought.

Since the Fed’s last meeting, a whirlwind of economic events have cropped up: the U.S. designated China a currency manipulator, the yield curve inverted for the first time in over 10 years, China and the U.S. ratcheted up their tariffs, and oil prices spiked as geopolitical tensions on the Arabian peninsula flared up.

All the while, President Donald Trump has continued to criticize the Federal Reserve, lambasting Fed officials as “boneheads” for not paying the “lowest rate” in the world.

Despite all the noise, the committee’s economic projections on components of the U.S. economy paint a brighter picture domestically. Policymakers actually increased their projections on U.S. GDP growth, with the median member now projecting GDP growth of 2.2% in 2019, a notch up from the median projection of 2.1% in the last dot plot release in June.

Source: Federal Reserve
Source: Federal Reserve

On inflation, policymakers appeared unmoved by developments since June. The new economic projections continue to project 1.8% of inflation in core personal consumption expenditures (the Fed’s preferred measure of inflation, which strips out food and energy prices). The Fed’s stated inflation target is 2%, and more dovish policymakers have argued that rate cuts could help the Fed address the persistent undershooting of its target.

The Fed statement today continued to describe inflation as “running below” its 2% target.

Regaining control of interest rates

The Fed decision also sought to address last-minute developments on Tuesday and Wednesday concerning a liquidity crunch in the repurchase agreement (or repo) markets. A rush for overnight financing led to a spike in interest rates as banks and broker-dealers scrambled for bank reserves to lend to one another. The result: the effective federal funds rate rose to 2.30% on Tuesday, five basis points above the high end of the Fed’s previous interest rate target range of 2% to 2.25%.

To bring interest rates back into its range, the New York Fed stepped in and provided liquidity by dusting off the playbook on its own repo facility, of scale unseen since 2008. After a brief technical problem, the New York Fed auctioned off about $53 billion in repo agreements on Tuesday morning and re-opened the facility on Wednesday with a $75 billion auction (the max it was offering that day).

In its decision today, the Fed had another short-term fix: lowering the interest it pays on reserves by 30 basis points instead of by 25 basis points (as it did with its target range).

Interest on reserves is a key tool for the Fed to steer interest rates to its target range; it will pay banks a rate in the middle of its range to park cash overnight, which it hopes will serve as a benchmark for banks to lend in the market.

By lowering interest on reserves more dramatically than the target range change itself, the Fed hopes to give itself more room for rates to float in its new range of 1.75% to 2%.

In May, the Fed made a similar move, lowering interest on reserves from 2.4% to 2.35%. At the time the target range was between 2.25% to 2.5%.

The liquidity crunch this week appears to be related to some bad timing: corporate tax deadlines and new waves of U.S. Treasury issuance created a double-punch of elevated cash needs for banks and broker-dealers.

Still, the episode raises questions over whether the Fed’s balance sheet, currently at $3.8 trillion, left too few bank reserves in the system.

The Fed did not announce any changes to its balance sheet, which stopped shrinking at the Fed’s last meeting.

The Fed’s next FOMC meeting will take place October 29-30.

Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.

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