Fed Minutes Offer Clues on Possibility of Dec. Rate Cut

With the Federal Reserve's release on Wednesday of its Oct. 30 meeting minutes, we now have clues about the inside debate -- and of what kind of data might prompt the Fed to resume cutting or even start hiking.

That October meeting was the one when the Fed cut its short-term interest rate target, but emphasized that further cuts were not in the offing. 

Fed Remains Fractured

In general, the Fed is a very collegial bunch. There is usually debate during a Fed meeting, but ultimately most of the decisions made are by consensus. Coming to this consensus seems to becoming more difficult, as the views among members are diverging. There seems to be a group of Federal Open Market Committee members who are extremely uncomfortable with cutting rates further.

The minutes mentioned several concerns, which this hawkish group seemed to have in common. First, the group felt the outlook hadn't worsened, so why cut more? Second, the FOMC projects inflation to rebound, so it asked why not just let that happen? Third, the rate cuts that have already been completed, it felt, need time to have an effect. Fourth, the labor market and consumer spending remain strong, and problems seem limited to business spending. And, fifth, the group felt that further easing could stoke bubbles in financial markets

Risk Vs. Reward

What isn't entirely clear is whether this hawkish cadre has convinced the rest of the FOMC to at least pause, or if pausing is more of a compromise among members while they wait for more data. The distinction is important and the key is the degree to which the rest of the FOMC believes there are risks to continuing to cut.

Part of this hawkish group's case is that continuing to cut could undermine the Fed's inflation credibility or stoke bubbles in the financial markets, or both. If the rest of the FOMC agreed with this risk-based theory, the bar to cut again is quite high. In other words, if the reason for pausing is because of the risks of low interest rates, then we need to see enough bad data to overwhelm that perceived risk. 

I actually think the answer may be neither persuasion nor compromise. The way the hawkish argument was set off within the release of the minutes was unusual, but mirrors how a similar case was presented after the September meeting. In context, it seems that we are talking about a clear minority view, and perhaps one that isn't all that persuasive to the rest of the committee. I could buy that the FOMC as a group has some worries about the five points made above, but downside risks to the economy overwhelm those concerns. 

Trade Clouds Everything

The minutes struck some amount of optimism that uncertainty about trade might be abating. This same optimism is what drove the S&P 500 4% higher since Sept. 30, so the Fed's view on this isn't new information, really. But its degree of certainty around this is notable. The minutes did not sound like the Fed felt that trade was the only problem with the economy, nor was it putting too much weight on any one "deal" getting done, nothing that: "Some risks were seen to have eased a bit, although they remained elevated. There were some tentative signs that trade tensions were easing, the probability of a no-deal Brexit was judged to have lessened... However, other downside risks had not diminished."

Risks Remain Firmly to the Downside

My best read of the data is that risks remain tilted to the downside. I also think this is the Fed's conclusion. In other words, I think if the data continues to be weak into the first quarter, regardless of what happens with the China trade deal, the Fed will be back to cutting. It is still in a risk-management mode, it just wants to take a pause to see how effective the rate cuts to date will be. 

I think it would take a truly overwhelming amount of bad news to convince the Fed to cut in December, but even modestly worse data will bring rate cuts in 2020. My view that interest rates are much more likely to fall in 2020 than rise remains very well in-tact. 

Too Much Guidance a Problem

Just before the Fed minutes were released on Wednesday afternoon, a report from Reuters came out that there were snags in the China trade deal. We will see where this story leads, but I'd point out that this is exactly why the Fed shouldn't have been so explicit after the October meeting. At that time, Fed Chair Jerome Powell went out of his way to say they wouldn't be cutting in December. As these minutes show, that was at least partially fueled by optimism about the trade outlook. But the Fed had to know this was a delicate negotiation that could break down at any time. Why be so vociferous in telling us it was done cutting for now? 

Ahead of the minutes, the yield curve was bull flattening on the bad news about trade. This means the 30-year Treasury was falling in yield more than shorter maturities. Since the 30-year is mostly a reflection of long-term growth prospects, the fact that this part of the curve is falling the most is a ominous signal from the bond market. I am certain that had Powell merely said that a December cut was up in the air, the curve will be bull steepening, with shorter bonds leading the way.