June 4, 2019 / 2:33 PM / 14 days ago

Instant View - Fed will respond 'as appropriate' to risks like trade war: Powell

(Reuters) - The Federal Reserve will respond “as appropriate” to the risks posed by a global trade war and other recent developments, Fed Chairman Jerome Powell said on Tuesday in remarks that seemed to open the door to the possibility of a rate cut.

FILE PHOTO: The Federal Reserve building is pictured in Washington, DC, U.S., August 22, 2018. REUTERS/Chris Wattie/File Photo

In a brief statement included as part of a speech on broader monetary policy issues, Powell said the Fed was “closely monitoring the implications” of a trade dispute that has, since the Fed’s last meeting, disrupted global bond and equity markets and posed risks to U.S. and world economic growth.

OTHER KEY POINTS:

** Fed’s Powell says with economy growing, unemployment low, inflation low and stable, it’s right time to rethink long-run strategies

** Powell sees much higher likelihood rates will fall to effective lower bound in a downturn

** Powell says Fed takes seriously the risk that persistent inflation shortfalls could reduce inflation expectations

** Powell says ‘dot-plot’ of Fed rate forecasts has distracted attention from how Fed will react to unexpected events

** Powell says in times of uncertainty, median Fed rate forecast might best be thought of as ‘least unlikely’ outcome

MARKET REACTION:

STOCKS: S&P 500 added to gains and was last up 1.16%

BONDS: U.S. Treasury yields fell; 2s at 1.9015%; 10s at 2.1314%

FOREX: The U.S. dollar index cut early gains and was last up 0.02%

COMMENTS:

PETER TUZ, PRESIDENT, CHASE INVESTMENT COUNSEL, CHARLOTTESVILLE, VIRGINIA

“Powell confirmed a bias toward lower, rather than higher rates going forward. Inflation seems to be pretty subdued and I think the Fed would like to see a pickup in inflation. The subdued level of inflation suggests that interest rates are more likely to move down than up. The main bulk of the speech is confirming the Fed’s two goals, containing inflation and promoting full employment and whether their current tools are adequate to do so.  That’s what (the Fed is) faced with today. Back when they started increasing rates, it was to give themselves more tools when the economy hits a soft patch again.”

“Whether the trade disputes are going to result in a slowdown in the economy, mandating a rate reduction is something (the Fed) might be watching quite closely. (St. Louis Federal Reserve president James) Bullard discussed the same thing. It’s an odd environment that they’re forced to deal with. It’s a good economy that could slow down, with very little inflation despite being strong.”

MICHAEL GERAGHTY, EQUITY STRATEGIST, CORNERSTONE CAPITAL GROUP, NEW YORK CITY

“Sounds like pretty neutral comments by the Fed Chairman. There were hopes of a rate cut earlier and they haven’t changed much because the comments were neutral and neutral isn’t negative. Investors are taking comfort in what appears to be a Fed that is contemplating on cutting rates if the economy materially slows down. “

JON HILL, INTEREST RATE STRATEGIST, BMO CAPITAL MARKETS, NEW YORK

“The phrase that we’ve certainly been paying attention to is ‘act as appropriate’ and what we see is this is Powell acknowledging the fact that inflation is running relatively low. The market is pricing in the Fed’s reaction function to cut rates and he’s basically acknowledging that in the data-dependent world he’s in there’s an increasing case to be built for cutting rates in coming quarters. I think it’s acknowledging where we’re at. We’ve seen inflation continuing to run low, but more concerning is the pretty dramatic drop we’ve seen in breakevens. The falling inflation compensation is telling the Fed that perhaps policy is too tight, so they are starting to acknowledge and build the case for the possibility of a cut. We still think June is probably a little too early, but not impossible. More likely this is starting to open the door for some easing later this year.”

BRIAN BATTLE, ADVISOR, PT ASSET MANAGEMENT, CHICAGO

“Powell delivered a speech saying they’re going to wait and see. That means there’s not an imminent cut coming. Everybody’s pricing in a fall cut. The Fed chairman just said they’re going to be patient and watch. Everything’s on the table but they’re thinking about it. 

    “Charles Evans Fed President in Chicago said we should wait and see and that’s important because he’s always the first guy in line to say we should cut. Charles Evans who’s very dovish is saying wait and see. 

    “The Powell Federal Reserve board is showing some cohesion here to say let’s put this message out to say there’s not going to be an automatic cut. Instead of an ease they’re betting a hold is going to do the job. 

    “I don’t think there was a change in tone. There might be some disappointment the Fed isn’t as concerned about a yield curve inversion as the market is. Maybe they think the inversion is transitory. It’s not a surprising speech from Powell. A bigger signal is Evans preaching patience, which is atypical for him.”

    

LARRY MILSTEIN, HEAD OF GOVERNMENT AND AGENCY TRADING, R.W. PRESSPRICH & CO., NEW YORK

“Powell’s comments were a little more dovish than I had expected. He understands inflation is below 2% and some inside the Fed are concerned about that. There are also concerns about trade. This speech is not a pushback against what the interest rates markets are showing. The Fed is ready to react if we see a slowdown. I don’t see a cut in June. That’s too soon. We saw the ISM number yesterday. It’s a weaker number but it’s still above 50. I say July at earliest (for a rate cut) but probably in September. If we cut a deal with China this summer, the Fed can wait until September. The market has gotten ahead of itself. I am looking at one or two cuts this year.”

WILLIE DELWICHE, INVESTMENT STRATEGIST, BAIRD, MILWAUKEE

“He is saying act ‘as appropriate’ to sustain an expansion. You could view that through the lens of the market which built on Evans’ comments from this morning saying there is information in the market-based signals. So maybe they are looking at not just what equities are doing but what Treasuries are doing and might not want to wait until data catches up to whatever the market signal is to get more accommodative or to have a policy response.”

“The other interesting thing...where he talks about the dot plot as being not as useful maybe as it could have been in the past. That is a focus right now because if you just look at the dot plot there has been no indication that rate cuts are anywhere in the Fed’s mindset and that’s one of the questions going into the June FOMC meeting is what do they do with that. Market expectations are so much for a rate cut, the dot plot says stable to higher rates. How do you resolve that and maintain credibility? And in doing this he is trying to do what he can to preserve Fed credibility and say well maybe the dot plot isn’t as useful now as it has been in the past because there’s more uncertainty.”

PHIL ORLANDO, CHIEF EQUITY MARKET STRATEGIST, FEDERATED INVESTORS, NEW YORK  

“That is consistent with the comment that Bullard made yesterday. Our view has been that we don’t think any activity by the Fed is appropriate near-term. The Fed dot plots have nothing going on this year and one more hike on board for next year. We don’t think that hike will ever happen. But the market is saying we should probably have 3 quarter-point cuts over the course of the next two years. We don’t know if that is appropriate either.”

“They are certainly giving the market a nod to sort of prop things up here. There is, something like a 25% chance they are going to cut rates at the June meeting. We don’t see that, but a lot of the market thinks that is going to happen. There is a 50% chance of a rate cut by July 31 and like a 90% chance by the September meeting. Our sense is the data isn’t that bad.

“That said, and this is what Bullard talked about yesterday, but suppose the uncertainty around trade is the biggest bugaboo right now. It is a complete uncertainty -  we have no way of knowing is this China-U.S. thing is going to blow up, if this Mexico thing is going to turn into a bigger deal and what might the impact be on business and consumer demand, economic growth, etc and that is what the Fed is correctly monitoring.”

JOHN DOYLE, VICE PRESIDENT OF DEALING AND TRADING, TEMPUS, INC, WASHINGTON D.C.

“Powell’s comments will be seen as slightly dollar negative but we might not see much of a move today because the greenback already fell yesterday after Bullard . His comments are not as aggressively dovish as Bullard’s yesterday but he does reiterate the same concerns: trade tensions and low inflation.”

“We are likely seeing the beginning of coordinated Fed-speak to prep market participants for at least one rate cut this year.”

JOSEPH SROKA, CHIEF INVESTMENT OFFICER, NOVAPOINT CAPITAL, ATLANTA

“(Powell) is reiterating that the Fed wants to be data dependent. He made the comment that the Fed will act as appropriate to sustain expansion. If conditions continue to weaken due to trade or other issues then the bias may be towards lower interest rates in the future. This is a big reversal from where we were 6 to 8 months ago when the fear was that the Fed was going to raise rates regardless of economic conditions. The market move is a combination of comments out of China that they believe trade disputes can be resolved through negotiations. This, followed by the possibility of rate cuts is being seen favorably by the equities market.

“With persistently low inflation and interest rates low by historical standards, the Fed chair mentioned that taking rates close to zero in an economic crisis would likely be an appropriate action.”

“The big unknown for the Fed right now is severity and duration of the trade dispute which is keeping them in this ‘wait and see’ posture.”

Americas Economics and Markets Desk

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