The Fed futures market is not paying any attention and is sticking with two more cuts this year

The markets got exactly what had been expected, a 25 bp rate cut, but was not prepared for some of the details. Among those was the new guy wanting 50 bp but the two who had argued for that earlier did not join him. This may well be shunning a political sycophant and speaks volumes about interference with the Fed.

The vote breakout is weird. A third of the board want to stand pat on the new current level. Together with those who want only one more cut, that’s almost half. Reuters notes “Powell's comments highlighted that divergence and suggested the last two meetings of the year would be close calls.”

The Fed futures market is not paying any attention and is sticking with two more cuts this year. Reuters reports “Market betting on the Fed interest rate trajectory through the end of next year see rates tumbling below 3% in a year's time, implying cuts of 125 basis points over that period, which is two more than Fed policymakers indicated on Wednesday. The implied 'terminal rate' for the cycle of 2.9% is some 35 basis points lower than it was just three months ago.” See the chart.

*Bonds were little changed—the 10-year was 4.03% before the announcement and 4.03% afterwards. Equities went a bit negative, surprising since the consensus seems to be another two cuts by year-end, which is what they wanted. The most jittery was FX, which put in some big spikes in both directions, as usual, if without real cause.

The WSJ calls it a “dovish diversity” of views. The newspaper also says “it’s Trump’s Fed now,” an insult that turns words on their head because what it means is that if inflation does skyrocket and jobs suffer, too, everyone will know it was Trump’s fault. Well, no. It will be the Fed’s fault because if inflation does get substantially higher, the Fed can’t do those next two cuts.

The WSJ calls the meeting “Powell’s Last Stand” and calls the rate decision a ”risky gambit.” This is weirdly unfair and untrue. Powell himself called it a risk management cut and explained the risk in great detail.  The Fed is not “confused” by the data—the data is contradictory.

Bloomberg has reporting we like better.  In one place, “It’s still Powell’s Fed.” Elsewhere, “Arguably the biggest surprise from yesterday’s Federal Reserve interest rate decision was that there was only one dissenting vote. Chair Jerome Powell managed to rally a deeply divided committee and tune out heavy political pressure to find middle ground. It’s clear the Fed chair “corralled the cats,” said KPMG’s Diane Swonk. But can the central bank’s independence survive Donald Trump?”

Some of the questions from the press were pointed and Mr. Powell fielded them gracefully. He declined to comment on Trump’s demand for multiple cuts. He was straightforward that inflation uncertainty arises from the tariffs and if we get higher inflation, it will be due primarily to tariffs. He admitted the labor situation is a tangled ball of yarn but it does include the loss of immigrants.

On the whole, a heroic performance.

We plowed through a mountain of comments. Nothing was terribly original. In the NYT, Larry Summers said  “Sometimes markets do better than is deserved based on the quality of policy. Between tariffs, wholesale attacks on Fed independence, deficits and attacks on the rule of law, there is much basis for uncertainty about our economic future.” No kidding. Also: “I think we may be at the foothills of stagflation. I don’t think tariff impacts have been fully felt or will be for some time, and confidence has more room to decline than to rise. I think inflation will surprise a bit on the high side. I suspect we are seeing unemployment and inflation forecasts both being revised up.”

As for tariff derangement syndrome, its inventor Furman commented “I have no doubt that tariffs are adding to inflation. The evidence is also consistent with them slowing economic growth as well as job growth. Ultimately American families will suffer as a result of them. But I also do think it is fair to say that I (and many economists) get more worked up about them than we do about other policies. It’s a bit in our DNA to believe in the gains from trade and some of the amazing insights economists have had on this topic for nearly 250 years. But just because we’re more emotionally invested doesn’t mean we’re directionally wrong.”

It was quite interesting to watch but in the end, we can expect two more rate cuts, and that is dollar-negative if everyone else keeps rates on hold. And oh, yes, the Fed sees growth at about 1.6% this year. The Atlanta Fed released yesterday its take on Q3—3.3%. Oh, dear

Tidbit: The St. Louis Fed has an article on the history of Fed board meeting dissents (A History of FOMC Dissents | St. Louis Fed). Bloomberg wrote that the July policy meeting had the first double dissent since 1993. A triple dissent would be unprecedented since 1988.

Forecast

We are still getting the sell-on-the-news effect, with most currencies down against the dollar for no reason based on fundamentals we can detect. The bond market yields barely budged, so it can’t be that. The most noteworthy may be the dollar/yen, which seems headed for a significant gain—but beware resistance at 147.63. 

In the end, the plausible explanation for a firm dollar is that the Fed decision is tilted toward hawkish. It’s weird to see hawkishness when the decision is to cut rates, but it’s not entirely silly. Remember that early last summer, more than one analyst expected rate hikes by January due to tariff-induced inflation. We expect this effect to wear away, but need to be careful. 

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