Fed Cuts Again, But Dissent Rises
- The Federal Reserve reduced the fed funds rate 25 bps this week, continuing to cite economic weakness overseas and “muted inflation pressures.”
- The higher pace of home sales and improving builder confidence should feed through to stronger construction later this year, meaning residential investment should finally contribute positively to GDP growth.
- Manufacturing production rebounded in August, but is still down over the past year.
- The surge in oil prices should have fairly limited effect on the U.S. economy, while the spike in repo rates was largely due to technical factors.
Fed Cuts Again, But Dissent Rises
The Federal Reserve reduced the fed funds rate 25 bps this week, continuing to cite economic weakness overseas and “muted inflation pressures” as justification to ease monetary policy.
The week certainly started with a bang, as oil prices surged after the weekend attack on Saudi Arabian oil facilities and a spike in overnight money market rates drove the Fed to undertake its first overnight repo operations since 2008. We would emphasize that neither is overly concerning for the U.S. economy. We estimate that even a 10% increase in WTI prices would raise year-over-year CPI inflation just 0.1-0.2 percentage points, which is relatively limited but does come at a time when importers and consumers are beginning to face a greater tariff impact. Yet the United States is now the largest oil producer in the world, meaning it is less vulnerable to external energy shocks. The jump in repo rates, meanwhile, was largely due to technical factors and the Fed’s actions are certainly not a new round of QE (see Interest Rate Watch).
The FOMC meeting produced no major surprises—the cut was widely expected—but was notable for the rising dissent among the committee. James Bullard preferred a 50 bps cut, while Esther George and Eric Rosengren wanted to keep rates steady. There were no major changes to the statement or to the forecasts for growth and inflation. On net, the dot plot and Powell’s press conference were received as slightly less dovish than expected. Seven of the 17 dots expected one more cut this year, indicating several committee members, but not a majority, favor further easing. We still expect a 25 bps cut in the fourth quarter and one more in the first quarter of 2020, but recognize that these are not set in stone, particularly as the range of views at the FOMC widens and consensus becomes harder to maintain.
With the Fed continuing to emphasize data dependence, the housing market, perhaps the most interest rate-sensitive sector of the economy, takes on greater importance as an indicator of the efficacy of monetary policy in shielding the domestic economy from weakness overseas and in manufacturing. Total housing starts jumped 12.3% to a 1.36 million-unit pace, the highest since June 2007, while existing home sales rose again in August, marking the first back-to-back increase since 2017. The roughly 130 bps decline in mortgage rates has boosted sales and firmed prices, and lower short term rates are helping homebuilders. Despite this, we suspect builders are cautious, wary of trade policy uncertainty and stock market volatility leading to a sudden pullback in demand. Still, the stronger sales pace and improving builder confidence should feed through to stronger construction later this year. After dragging on overall GDP growth for six straight quarters, residential investment is finally poised to boost growth in the third quarter and through next year.
Industrial production rebounded 0.6% in August, with a strong 0.5% gain in manufacturing output. Compared to a year ago, manufacturing production is still down, but August’s report suggests the situation is at least not worsening at the moment. Powell largely stuck to his core message this week—the situation with trade is extremely fluid and out of the Fed’s control. It will respond as the situation evolves, doing what is necessary to prolong the expansion. We expect that means two more cuts, but dissent is rising.