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Fed Lowers Rates While Stressing Economic Stability

Eric Compton (eric.compton@morningstar.com)

Even though the economic backdrop appears to be fairly benign in the United States, without any obvious signs of major distress, this was probably the most anticipated Federal Open Market Committee meeting of the year, with futures markets already pricing in a 100% chance of a rate cut ahead of the July meeting. While there were questions about whether the Fed would stick to the same script it has laid out at previous meetings--no rate cuts, staying patient, willingness to react to incoming data (which has been more positive than expected of late)--or whether it would do what the market expected and cut rates for the first time since the 2008-09 financial crisis, it ended up being a foregone conclusion. 

At the end of its July meeting, the FOMC voted to decrease its target rate range to 2.00%-2.25% from 2.25%-2.50%. It was not without dissent, though, as for the second time during Jerome Powell's tenure the vote was not unanimous, with Esther George (Federal Reserve Bank of Kansas City) and Eric Rosengren (Federal Reserve Bank of Boston) voting to keep the federal-funds rate stable. The Fed also announced that it would cease its balance sheet runoff in August rather than September, but would continue to reinvest its holdings of agency MBS into Treasuries.

What does this mean for our core banking coverage? As of now, we are incorporating three rate cuts (including this one) through 2020 into our bank forecasts. This has affected our fair value estimates on these names by 2%-4% on average. Given how mixed the economic data is, with more positives appearing lately than negatives, it would not seem unreasonable to think the Fed may not cut two more times from here. We would, however, note that the fair value estimates for the banks are not all that sensitive to the differential between one cut and three cuts, such that in the end this may end up simply being noise.

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