Federal Reserve watchers just last month were on edge for signs that the U.S. central bank could bank start hiking again. Now, they’re ready for the opposite.
Days after officials on the Federal Open Market Committee (FOMC) voted to leave interest rates unchanged for the third time this year, the Trump administration’s decision to escalate its trade war with China led many market participants to bet aggressively that the Fed would soon cut interest rates. Nearly 24 percent of investors are hedging that this will happen as soon as next week, when Fed officials make their next decision.
But don’t bank on it. Economists are largely expecting that it’s still too soon for the Fed to cut, meaning officials’ “make-no-move” policy posture will likely extend for another month with interest rates left on hold.
There’s still, however, going to be a lot to chew on – and maybe even more than usual. In addition to their interest rate decision, officials will release fresh forecasts for economic growth, employment, inflation, and – most famously – for the federal funds rate over the next three years, through it’s so-called dot plot.
Here are four key themes to keep an eye on – and how they could impact your wallet.
1. Move along, no rate cut to see here
Fed officials have signaled a willingness to lower rates, should the downside risks take hold, but odds are they’re not quite ready to make it happen.
That’s partially because officials would like to see more proof in the data that the U.S. economy is indeed struggling against the massive amount of headwinds it’s trying to withstand.
An unexpectedly weak May jobs report showed that employers tapped the brakes on hiring, adding a scant 75,000 new employees to their payrolls versus expectations for 185,000. Though that was a shocking number, it’s still far too soon to call that the new job market trend.
“There’s a tendency to freak out at the headline number (of each employment report), but some slowing of job growth is natural,” says Greg McBride, CFA, Bankrate chief financial analyst. “But it often gets conflated with a recession. A car going 60 miles an hour that slows to 40 miles per hour is far different from a car that has come to a screeching halt and is slammed into reverse.”
A report of that nature wouldn’t start to be a concern to officials unless the next jobs figures also contained drastic surprises to the downside, McBride says. Think the initial reading on hiring in February, which showed that employers added only 20,000 new positions to their payrolls. If that headline number were to follow May’s 75,000, “then I think you could start to worry,” McBride says. “That’s evidence that uncertainty about the economy is impacting hiring.”
At the same time, other figures have shown a mostly positive picture for the U.S. economy. The national unemployment rate in May held at 3.6 percent, the lowest in almost 50 years, while growth in the first quarter of 2019 registered well-above expectations, albeit on more volatile categories.
“You look at the economic numbers, and it’s not exactly the environment where the Fed is cutting rates repeatedly,” McBride says.
It’s not as if officials haven’t cut rates before when the figures still looked good. They’re called “insurance” cuts, and they’re meant to prop up the economy as a preventive measure. Two have taken place in the past: once in 1995 and another in 1998.
But before those “insurance” cuts are enacted, officials might wait for more clarity. As always, there’s the case that developments could change. After White House officials announced higher tariffs on goods from China, they also threatened to hit all imports from Mexico with levies. Those tensions have since resolved. The president could also decide to not follow through with slapping duties on all remaining goods from China.
“Markets have rebounded just since the Mexico tariffs got taken off the table,” McBride says. “I think that takes a lot of the pressure off. A lot of that uncertainty and tension seems to have dissipated.”
2. Listen for signals of a cut
But that doesn’t mean we haven’t gotten hints from the Fed that more accommodative policy is coming.
St. Louis Fed President James Bullard said a rate cut “may be warranted soon,” given low inflation and the ongoing trade tensions between China and, at the time, Mexico. This meeting will really be the time to learn whether the Fed is actually positioning itself for an imminent rate cut – and what officials would have to see in order to do it.
“From the Fed’s perspective, they need to think about, ‘Do we want to be proactive? Is it OK, from a policy perspective, to provide more accommodation?” says Sarah House, director and senior economist at Wells Fargo. “Or do we want to wait it out, rather than try to predict what the administration is going to do and how that will impact the economy?”
House’s base case calls for two rate cuts this year, one in the third quarter and a second in the fourth quarter.
Watch for key buzzword ‘patient,’ as well as mentions of downside risks
If you’re trying to watch for those signals, pay attention to any use of the Fed’s favorite word since January — “patient.”
When Fed Chairman Jerome Powell first started using the word, it was meant to convey that officials were in no hurry to hike rates. As the situation evolved, it became a way for officials to express that they were in no hurry to cut them.
Now, “we haven’t heard them use the word patient nearly so often as they were one-and-a-half to two months ago,” House says.
If the Fed decides to avoid the word altogether next week, it’s going to be a clear signal that they’re no longer comfortable waiting and an adjustment is coming. And with the current outlook the way it is, it’s safe to infer that this adjustment won’t be a hike.
“You might instead see something along the lines of, they’re carefully monitoring global economic and financial conditions and will make adjustments accordingly and basically remove that patient word,” House says. “That would be a more clear sign of the chances of them moving soon is coming.”
That applies to both the press conference and the post-meeting statement. Since January, officials have included this sentence in its announcement immediately following their interest rate decision: “The Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” If the Fed gets rid of it, and instead replaces it with a sentence along those lines of “monitoring the global economic and financial conditions,” that’s going to be a meaningful distinction.
It would also be important if that statement is revised to reflect Powell’s June 4 remarks at a Fed conference in Chicago. Powell said the committee was monitoring the trade tensions closely and would “act as appropriate to sustain the expansion,” which was interpreted as leaving the door open to a cut.
But the Fed could also signal a cut is coming by talking about the economic outlook with a less favorable tone. Watch for the phrase “risks are tilted toward the downside,” says Richard Moody, senior vice president and chief economist at Regions Financial Corporation.
“They can pretty much make it implicit that their next move is going to be a cut without coming out and using those words,” Moody says.
3. Watch the dots
The Fed may also indicate its next move when it updates its dot plot. This chart shows Fed officials’ forecasts for where interest rates are expected to be over the next three years. Economists mostly pay attention to the dot in the middle (the median value) when trying to get a feel for the committee’s consensus view.
The dot plot in March showed that the median estimate among the committee called for a federal funds rate of 2.375 percent, where it is now. That meant that no rate hikes were on the table. At that time, however, six officials broke away from the majority and penciled in at least one rate hike this year.
It’ll be worthwhile to pay attention to any shifts in the dot plot, House says. Though it’s not a commitment, “you could still see perhaps how nervous some of these folks are based on how many of the dots shift down,” she says. “If the trade situation changes very rapidly, as you’ve seen it certainly can, we would at least get a sense of how ready policymakers might be.”
It’s unlikely that the median forecast for the federal funds rate at the end of this year will shift down. Seventeen officials are on the committee, so that means nine officials would have to move down their dots for there to be such a downward revision.
“That’s a very high bar,” Moody says, ”which is why I don’t think the median is going to move. But it’s worth watching to see how many people signal a rate cut.”
If this does happen and a few officials do move down their dots past the current median level, it would be a historic moment for the Fed and this aspect of central bankers’ communication. The dot plot has never forecast a rate cut before. “It’s just not been around long enough,” Moody says.
Because Bullard has already said that a cut “may be warranted soon,” it’s very likely that he could choose to shift down his dot, House says. And if the six officials still forecasting a rate hike move their dots down to where the federal funds rate is currently, that would be meaningful, too.
“It would suggest which ways the risks are skewed,” she says. “Generally, you see the group move together. If some of the participants are getting more nervous about the overall outlook and thinking (there will be) no more rate hikes, you would think that some of the more dovish members of the committee might be thinking it’s not enough to just stay on hold, that we do need to be a little bit more aggressive.”
4. Where art thou, inflation?
All the while, inflation is still a wildcard for Fed officials.
The Fed’s preferred way of seeing how price pressures are faring in the economy is the Department of Commerce’s core personal consumption expenditures index, which excludes the volatile food and energy categories. That gauge edged up slightly in April to 1.6 percent, but is still stubbornly below officials’ target of 2 percent. Meanwhile, the consumer price index, a separate gauge that the Fed still tracks, cooled in May.
It’s important to pay attention to low inflation this time around because the still-pervasive issue might just give the Fed more elasticity with implementing a rate cut, should it be necessary.
“It definitely gives them more scope to cut rates than usual because inflation isn’t as much of a threat. If anything, it’s on the downside,” House says. “This gives them more flexibility to act now rather than later.”
How to prepare for the Fed’s actions
When Powell said the Fed was prepared to act as “appropriate” to sustain the message, markets cheered the message that the U.S. central bank could come to the rescue.
But that might not be the right conclusion for you – or your wallet.
“You’ve got to be careful what you wish for,” McBride says. “Financial markets are operating on the premise that, once again, bad news is good news.”
It’s important to remember that policymakers on the U.S. central bank are data-dependent, and they are acting to sustain an economic expansion. That means, if a rate cut occurs, it’s because they think the economy is in desperate need of stimulation, or could be about to fall off a cliff.
“Even if they did cut rates at this point, what kind of signal does that send about where they think the economy is, or is going?” McBride asks. “If you know the Fed is moving itself toward cutting rates, and there’s legitimate concerns about the economy slowing significantly and the recession word keeps getting thrown around more, that undermines all of those goals that Main Street America has.”
When the Fed decides to cut rates, it’s important that you’ve prepared your finances in advance, while the U.S. economy is still strong, McBride says.
“Continue to boost your savings, pay down debt, create some breathing room in your budget, pay off high-cost debt,” McBride says. “Those are the prudent steps to take. Don’t really worry so much about the guesswork of interest rates. Whether the economy is firing on all cylinders or not, it’s not going to stay that way forever. It’s not so much a sky is falling kind of thing as much as it is, trees don’t grow to the sky.”