By The Nation
At its July meeting, the Fed voted to cut the federal funds rate target range by 25 basis points, to 2.00 per cent-2.25 per cent. Committee members Esther George and Eric Rosengren dissented, confirming some resistance from regional FRB presidents to cutting rates at this stage of the business cycle.
The minimal size of the cut, the dissents, and Fed chairman Jerome Powell’s press conference comments disappointed markets, undercutting investment bank Morgan Stanley’s expectations, according to a statement released on Thursday.
Powell’s statement that the cut was “in the nature of a mid-cycle adjustment to policy” provided little dovish guidance for future policy moves, said the research statement.
“We expect a follow-up cut of 25 base points this year, and we judge October as the most likely timing,” the Morgan Stanley research paper said.
In the near term, the pricing of future Fed policy beyond another 25 point rate cut will hinge more on the evolution of more domestic, service sector data, than on global growth data, associated risks emanating from global trade, and their consequent impact on US manufacturing. Morgan Stanley suggested that investors exit all nominal and real rate positions that they had predicated on their previous understanding of the Fed’s reaction function.
“In TIPS, we stay neutral on break-evens, given Powell’s expectation of a ‘delayed’ move toward 2 per cent inflation. We exit our 5s30s real rates steepener. We also put some context on the Fed’s early end to balance sheet normalisation and what it means for real yields and break-evens,” said the research. “We see a muted impact on real yields, and mild support for breakeven tightening (not widening), given that the Fed buys lower duration in TIPS vs outstanding nominals.”
The early end to balance sheet normalization could alleviate some of the funding pressure Morgan Stanley expects to see, but they still expect over US$150 billion (Bt4.16 trillion) of T-bill issuances in August, said the report. “Further, we reiterate our view that POMOs will begin in the fourth quarter of this year as reserves will dip below $1.3 trillion in October and approach $1.2 trillion by December. Lastly, we project that EFFR-IOER will be in the 8-10 basis point range by the September meeting.
“Fed hawkishness may give the USD a bid, but we argue for caution. USD strength exacerbates the issues that concern the Fed the most – global growth, trade and inflation. The more cautious the Fed is on rate cuts, the higher the probability that financial conditions tighten, making future rate cuts more likely. We thus argue that the higher the USD rally, the bigger the subsequent USD decline.”