Market Insider

Fed 'insurance' cut gets cold shoulder from markets

Key Points
  • The Fed disappointed some market players who were looking for it to forecast more rate cuts for this year.
  • Stocks initially sold off but closed mixed and flattish, and the bond market saw rates move slightly in both directions.
  • Fed Chairman Jerome Powell indicated the Fed was making a so-called insurance cut, noting it is not on a pre-set course and it will monitor economic data—a message that was taken as hawkish by some investors.
Federal Reserve Chair Jerome Powell holds a news conference following the Federal Reserve's two-day Federal Open Market Committee Meeting in Washington, July 31, 2019.
Sarah Silbiger | Reuters

The Federal Reserve cut interest rates by a quarter point Wednesday, but it also signaled its latest rate cut was meant to serve as insurance against negative hits to the economy and not part of a longer rate cutting cycle.

Stocks sold off initially but ended mixed and flattish. The Dow was up 36 to 27,147; the S&P 500 ended up 1 at 3,006, while the Nasdaq fell 8 to 8,177.

Bond yields rose at the short end, with the 2-year at 1.75%, the rate that most sensitive to Fed policy. The long-end, the 10-year yield was slightly lower at 1.79%.

"I think maybe the market is a little disappointed because they expected the dots to move," said Drew Matus, chief market strategist at MetLife Investment Management. The Fed displays its interest rate forecasts on a chart, known as the "dot plot" and it showed no more rate cuts this year.

Art Cashin, head of floor operations at UBS, said some traders in the stock market were looking for two more cuts to be forecast for this year, and some traders were clearly disappointed.

"If they really want to convince people these are insurance cuts, then they're done. They're done for this year," Matus said.

Matus said global growth and trade remain a concern for the Fed, and it could still make a third cut this year. The Fed trimmed the Fed funds target rate range to 1.75 to 2%, in its second rate cut since July and second in more than a decade.

"If they try to put in a fourth one, there will be a lot more dissenters," Matus said. "My expectation is where the economy is heading over the next couple of months is pretty good. You could make the case you didn't need this cut." Matus said he personally didn't see the need for cuts this year.

Three of the Fed's voting members voted against the cut, with Boston Fed President Eric Rosengren and Kansas City Fed President Esther George both opposed for a second time.They don't believe the economy needed looser policy, but they were joined by St. Louis Fed President James Bullard, who wanted the Fed to be more aggressive with a 50 basis point cut.

According to the dot plot, five members had wanted to hold rates steady Wednesday, while five agreed with a quarter point cut and seven others wanted to see at least one more cut this year. The voting members voted seven to three to cut by a quarter point.

"This does skew hawkish," said Jon Hill, BMO rate strategist. "I think it just reflects the committee didn't pre-commit to a third cut this year." He noted that the Fed statement and Powell said that the Fed would "act as appropriate," meaning it will make its decisions based on the economy's performance.

Powell also said Fed policy is not "pre-set."

"Back in June, the median showed no cut in 2019. This isn't pre-set policy This is we'll see how things progress, and go from there. All things considered, it's largely consensus expectations. but bordering on slightly hawkish," Hill said.

Powell also addressed a liquidity crunch in the short-term funding market that sent rates spiking there Monday and Tuesday. That is a market where financial institutions fund themselves.

The chairman said there were concerns there would be a large demand for cash this week because of Treasury settlements and tax payments, but the Fed didn't anticipate how volatile it would be.

Some rates jumped as much as 10% before the market calmed down. The squeeze pushed the Fed's own target rate above its range on Tuesday, to 2.3%. In an unusual move, it rose above the high end of the then fed funds rate range of 2 to 2.25%.

The Fed carried out two market operations Tuesday and Wednesday and announced a third for Thursday. Strategists say the cash shortage does not appear to be related to a credit issue and appears to be a cash crunch.

During the post-meeting press briefing, Powell said the Fed was monitoring the situation and would act as needed.

"I think we were expecting them to be a bit more aggressive to either confirm a repo facility," said Hill. "By confirming they want to enter the market with a repo facility, as needed, it's not a standing facility but it's kind of a backdoor one."

Matus expects the short term funding market to be volatile over the next several weeks.

"I can't pinpoint what happened. And I'm not sure anyone can. I'm not sure the Fed knows because he said he's going to learn over the next six weeks. I'm taking away from that that the funding markets are going to be more volatile over the next six weeks." Matus said. "They don't have a solution because in part, they're still learning. The market is very different than it was before the crisis. When we began the restart of normalizing policy, this is one of the things that was going to be a learning experience."