FOMC Preview – Calm Facade, Turbulent Currents

This Thursday, we expect the Fed to continue its easing cycle by reducing the policy rate for the second time, now by 25bps. This week’s decision follows the meeting where the Fed surprised economists by starting the easing cycle with an initial 50 bps cut. The dot plot was suggestive of a divided FOMC; ten members signaled a rate of 4.5 or below by year end, requiring at least one 50 bps cut, while nine gave a rate of 4.75 or above by year end, which could be achieved by steady 25 bps. The former group won out, but was unable to obtain a unanimous decision, as Michelle Bowman gave the first dissenting vote of a Fed Governor since 2005.

Data since then is unlikely to have brought these two camps closer together, as there was sufficient fuel to support both stories. For the hawks, we got strong Q3 GDP growth at 2.8%. final purchases, one of Powell’s favorite measures to assess underlying demand, came in at an annualized 3.5%, the strongest in a year. Inflation came in hotter than expected for September, with m/m core PCE, the Fed’s favorite gauge, at 3.1% annualized. Recently, elevated readings were predominantly supported by housing services inflation. This did not worry the Fed so much, as underlying price pressures had waned. This time, non-housing services inflation was the culprit, which can easily be interpreted to be more concerning. September also saw a surprisingly strong labour market report, with non-farm payrolls increasing by 223k.

The doves similarly have enough data points to back their arguments. October non-farm payrolls came in at a mere 12k, and private payrolls decreased for the first time since 2020 (-28k). While the unemployment rate was stable, this was partly due to a decrease in the participation rate, but mostly because of rounding to one decimal. JOLTS job openings for September declined rapidly, leading the vacancies to unemployed ratio to drop to 1.08 - still marginally above the July low. The Q3 growth figure saw a drying up of private investment, and while consumption remains strong, it’s not broad-based. The Beige book, which was influential in the September decision, improved somewhat, but it still paints quite a dreary picture.

Markets and economists are similarly reacting strongly to any data releases, partly because of the oft-repeated approach of data-dependent meeting-by-meeting decision making. All the abovementioned data points can be interpreted in the opposite way, by looking at more granular decompositions, where certain subcomponents can tell any preferred story. Our own view on data releases over the past month, is that they are of limited use at this juncture, as they are plagued by various seasonal and other distortions, ranging from the standard seasonal adjustment, but also dynamics surrounding the US elections. These issues, in particular the latter, are also certainly in the mind of the Fed, as the outcome may or may not be known at the time of the meeting.

The Fed therefore has a difficult meeting ahead. The ultimate outcome will likely be deceivingly straightforward; a 25 bps cut which is already priced by markets, a little changed press release, a press conference which will repeat the narrative that the Fed is simply reducing restrictiveness, rather than actively easing. The behind the scenes discussion will be much less simple. With the FOMC split across the mandate, the debate will be fierce, but will be important for shaping path beyond November.