THE DAILY EDGE: 20 JUNE 2019

Fed Holds Rates Steady, Hints at Cuts if Outlook Doesn’t Improve Central bank’s rate-setting panel says it ‘will act as appropriate’ to sustain an expansion currently clouded by trade fights

“The case for somewhat more accommodative policy has strengthened,” Fed Chairman Jerome Powell said at a news conference after the central bank announced its decision. Still, citing recent favorable economic data, The Fed didn’t bow to pressure from President Trump for an immediate rate cut. (…)

“It’s really trade developments and concerns about global growth that are on our minds,” Mr. Powell said. Because many of these issues had arisen suddenly, many Fed officials wanted to wait a little longer before cutting rates, he said. (…)

Interest-rate projections released Wednesday showed eight of 17 officials—the reserve bank presidents and board governors who participate in the Fed meetings—expect they will cut the benchmark rate by year’s end from its current level in a range between 2.25% and 2.5%. Seven of those officials see lowering the rate by a half percentage point by the close of 2019, and one expects just a quarter-percentage-point reduction. Eight officials projected the Fed would hold rates steady, and one projected a rate increase. (…)

More from Powell:

(…) Committee participants’ growth projections from 2019 are little revised from March, with a central tendency of 2.0 percent to 2.2 percent, just above their estimates of longer-run normal growth rate. The growth projections for the year as a whole mask some important details about the composition of growth. Annual growth will be boosted by the surprisingly strong first quarter, which had just been reported at the time of the May FOMC meeting. As I noted then, the unexpected strength was largely in net exports and inventories–components that are not generally reliable indicators of ongoing momentum.

The more reliable drivers of growth in the economy are spending on consumption and business investment. While consumption was weak in the first quarter, incoming data show that it has bounced back, and is now running at a solid pace. In contrast, the limited evidence available at this time suggests that growth in business income has slowed in the second quarter. Moreover, manufacturing production has posted declines so far this year. Thus, while the baseline outlook remains favorable, many FOMC participants cited the investment picture and weaker business sentiment, and the crosscurrents I mentioned earlier, as supporting their judgment that the risk of less favorable outcomes has risen. (…)

The central tendency for 2019 core inflation–which omits volatile food and energy components–is between 1.7 and 1.8 percent. (…)

We are firmly committed to our symmetric 2 percent inflation objective, and we are well aware that inflation weakness that persists even in a healthy economy could precipitate a difficult-to-arrest downward drift in longer-run inflation expectations. Because there are no definitive measures of inflation expectations, we must rely on imperfect proxies. Market-based measures of inflation compensation have moved down since our May meeting and some survey-based expectations measures are near the bottom of their historic ranges. Combining these factors with the risks to growth already noted, participants expressed concerns about a more sustained shortfall of inflation.

(…) our deliberations made clear that a number of those who wrote down a flat rate path agree that the case for additional accommodation has strengthened since our May meeting. This added accommodation would support economic activity and inflation’s return to our objective. (…)

Goldman Sachs:

(…) While the nearly bi-modal distribution of the 2019 dots (7 dots at a 2-cut baseline, 8 with an unchanged baseline) suggests a divided committee, in the press conference Powell suggested that there was a broader consensus moving in the direction of rate cuts and did nothing to discourage the interpretation that his own dot is calling for lower rates this year. (…)

We expect two 25bp rate cuts this year, most likely in July and September. (…)

Based on the data (dot plot), this is a very bi-polar Fed: 7 very dovish with 2 cuts, 8 stay-put-no-cut. So long the data-dependent Fed, so long the dot plots. The guy doing the presser has the dominant dot.

World Looms Large in Fed Rate Plans Like it or not, the Fed is the world’s central bank. Thus, it is now signaling it will likely cut rates in coming months, not because the U.S. is headed into recession, but because shadows are growing over the rest of the world.

(…) On Wednesday, the Fed held interest rates steady while indicating a rate cut could come soon, a notable shift from just seven weeks ago when it saw no case for any rate adjustment. In explaining what changed, Fed Chairman Jerome Powell cited two developments in particular: a downturn in indicators of global growth and a worsening of trade tensions, which are damping confidence throughout the world, not just the U.S. (…)

The Fed’s current policy rate of 2.25% to 2.5% is now the highest among major advanced economies. Australia cut rates to 1.25% from 1.5% earlier this month. Canada’s key rate stands at 1.75%, Britain’s at 0.75% and Japan’s at negative 0.1%. The European Central Bank’s target rate is negative 0.4%, and on Tuesday its president, Mario Draghi, signaled it may go more deeply negative. (…)

More generally, the dovish direction of its foreign peers should prompt the Fed to reconsider whether 2.25% to 2.5% is appropriate. Though stimulative by historical standards, it may be restrictive in a low-inflation, slow-growing world. (…)

Ironically, the Fed, because of its attention to global developments, may end up delivering the interest rate cuts Mr. Trump also wants.

But substantially because of the damages that Trump’s tariffs, actual and threatened, have caused.

Lighthizer Plans Call With Chinese Counterpart Ahead of Trump-Xi Talks

(…) In addition to his planned telephone call, Mr. Lighthizer signaled that he and Treasury Secretary Steven Mnuchin, who is also taking a leading role in the talks, will meet Chinese officials in Osaka.

China, U.S. to resume trade talks but China says demands must be met  Top Chinese and U.S. officials will resume trade talks in accordance with the wishes of their leaders, but China hopes the United States will create the necessary conditions for dialogue, the Chinese commerce ministry said on Thursday.

(…) “We hope (the United States) will create the necessary conditions and atmosphere for solving problems through dialogue as equals.” (…)

But three main differences remain, including the removal of all additional tariffs, China says. Both sides have disagreed over trade purchases and a “balanced” text for any trade deal.

Those three “matters of principle” cannot be compromised, China has said.

Asked if China’s demands for a trade deal were still tied to the three issues being met, Gao said: “China’s principles and basic stance on Sino-U.S. economic and trade consultations have always been clear and consistent, and China’s core concerns must be properly resolved.” (…)

“Both sides have immense mutual interests. I believe by taking care of each other’s concerns through equal dialogue, both sides will for sure be able to find a solution to solve the problems properly,” Gao said. (…)

China has managed to get the United States back to the table with its determination and ability to “prepare for war”, Taoran Notes, a widely read and influential WeChat account run by the Economic Daily, wrote late on Wednesday.

“Only by being able to fight, daring to fight and being good at fighting can you stop a war,” it wrote. (…)

Union Pacific Says Uncertainty, Harsh Weather Behind Decline in Shipments CEO Lance Fritz says railroad’s second-quarter volumes are off about 4% but that the U.S. economy remains fundamentally healthy

(…) “We can see that when it comes to restocking and inventories, we can see it when it comes to dialogues I have with customers about their capital investment plans,” he said. “And I think that’s in part driven by the uncertainties surrounding trade.”

Shipping volumes across the railroad sector have been falling this year. Carloads fell 2.1% in May compared with the prior year, and then declined 9.1% and 4.6% in the first two weeks of June, according to the American Association of Railroads, an industry trade group. Volumes of key commodities including coal, forest products and metals used in manufacturing have been tumbling at a steep rate, and a decline in intermodal truck-rail loads has accelerated this month. (…)

Did you miss yesterday’s Edge and Odds discussing the Economic Outlook from Freight’s Perspective? You should read it.

SENTIMENT WATCH

Prepare to be swamped with scenarios “After The First Rate Cut”. Some facts:

• There has never been just one cut. Minimum: 75 bps.
• Beware averages and medians. Equities sank 12% in 2001 and 18% in 2007 in the 12 months following the first cut. The first chart is from SentimenTrader, the second from GS. I cannot say if they both cover the same periods.

• Whether we have a recession after the first cut matters a lot…David Rosenberg says that

the S&P 500 is down 37% from the time of the first easing to the ultimate bottom in the market when we confront an economic downturn. In those other periods when the Fed is fighting a financial spasm and/or soft-landing in the economy, the average decline to the low is 3.5%.

Valuation-wise, the S&P 500 is now back to the Rule of 20 Fair Value of 2951.

Iran Downs U.S. Military Drone Amid Rising Tensions Iran said it shot down a U.S. military drone, the latest in a series of skirmishes across the Middle East that have stoked fears of a wider military conflict