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Fed disappoints markets by sounding more 'neutral' than dovish

Key Points
  • In cutting interest rates for the first time in more than a decade, the Fed did not clearly signal that it would continue cutting rates.
  • That created fluctuations in financial markets with stocks heading lower and then recovering.
  • The bond market sold off, with yields hitting lows of the day prior to the Fed decision, but yields rose and dipped again after the 2 p.m. statement.
US Federal Reserve Chairman Jerome Powell speaks during a press conference after a Federal Open Market Committee meeting in Washington, DC on July 31, 2019.
Andrew Caballero-Reynolds | AFP | Getty Images

When the Fed, as expected, cut interest rates by a quarter point, it disappointed markets because it did not tip its hand on future rate reductions.

Bond yields fluctuated, but were off lows of the session, which were hit right before the 2 p.m. ET Fed statement. Yields rose and backtracked, and stocks fell. The 2-year yield was at 1.83% and the Dow was down about 50 points just before Fed Chairman Jerome Powell began speaking at 2:30 p.m. ET.

"Reading the statement, they're basically just leaving it open. It's a cut and we're going to play it by ear. We're not precommitting to any future move," said Peter Boockvar, chief investment officer at Bleakley Advisory Group. "We gave the market what you wanted. We're going to play it by ear. The first paragraph on growth on the economy and inflation was basically identical to June when they did not cut."

Two Fed officials, Kansas City Fed President Esther George and Boston Fed President Eric Rosengren dissented, as expected, but the dissents themselves create a lack of clarity about future policy.

"They threw in one statement on … global developments … and we got two dissents as expected," said Boockvar.

The Fed also ended its quantitative tightening program two months early, as expected. That program involved the rolldown of securities on the Fed's balance sheet, which the Fed will now replace as they mature.

"We have to see Powell's press conference for the tone and nuance around their outlook. It's a little more neutral than I would say dovish. They ended the balance sheet early and there were two dissenters," said John Briggs, head of strategy at NatWest.

The Fed revised its statement to include that it was cutting rates because of "the implications of global developments for the economic outlook as well as muted inflation pressures"

Strategists said the Fed was facing the difficult task of explaining why it was cutting interest rates at a time when U.S. data appears to be improving. The Fed has been citing soft inflation and concerns about global growth and trade war uncertainties.

Economists have been expecting the Fed to signal more cutting. "If you get 25 [basis point cut] today, it probably means another one is going to follow," said Jefferies chief financial economist Ward McCarthy just before the statement was released at 2 p.m.