The Fed Can't Give Markets the Certainty They Desire

(Bloomberg Opinion) -- Federal Reserve Chairman Jerome Powell tried to thread the needle between dovish and hawkish at his Wednesday press conference, but realistically had no hope of pleasing market participants who thought a series of interest-rate cuts were already in the bag. The Fed just isn't there yet. This reduction in rates was the insurance against bad outcomes. Going forward, conditions will need to worsen – and soon - to justify a further easing of monetary policy.

The outcome of the July Federal Open Market Committee was largely as I anticipated. The Fed reduced its target for the federal funds rate by 25 basis points in response to a weaker and riskier global environment in the context of little inflation pressure in the U.S. and they left open the possibility of future cuts. Still, the statement felt less dovish than the one in June, offering less of a guarantee to a rate cut at the next meeting in the third week of September.

Powell did leave plenty of clues to guide markets, though the ride won't likely be smooth. He specifically discussed a variety of factors such as global growth, trade policy, manufacturing activity, job growth and unemployment, inflation, and business confidence and investment. The problem here is that some of these factors are subjective and collectively offer no clear policy path. For instance, Powell said job growth remains sufficient to put downward pressure on unemployment. He also cited faltering business confidence and weak business investment. At the same time, trade tensions have gone from “boiling” to “simmering.”

Which of these factors are most important? Opportunities for communication snafus abound as different Fed officials will focus on different parts of the puzzle. In fact, the lack of clarity about the reason for a rate cut likely contributed to financial markets getting far ahead of the Fed in terms of how much easing would be necessary this year.

At the risk of oversimplification, this is how I am viewing the likely policy path: Given the dovish shift by the Fed and the fact that in June roughly half of the FOMC participants anticipated two rate cuts this year, the odds favor a rate cut in September assuming risks do not dissipate and overall economic conditions do not suddenly improve. To be sure, I can't say that a rate cut in September is a lock the way it was in July. Two good jobs reports between now and the next meeting could be enough to stay the Fed's hand.

That said, my instinct says there isn't enough time between now and September's meeting for the Fed to conclude that the threat to business confidence and investment has entirely dissipated and, hence, the Fed will think they need to add an additional policy boost. Beyond September, we will definitely need to see an intensification of risks, such as an increasing chance of a hard Brexit or renewed trade tensions, or a clear deterioration in the forecast that threatens to send unemployment rates higher to justify a rate cut.

In short, the status quo is likely sufficient to push the Fed into another rate cut, but not sufficient for more. To get a full 75 basis points of cuts this year, as the markets have been pricing in, the overall environment needs to get worse.

Be prepared to be frustrated by Fed policy for the foreseeable future. Absent a recession, the Fed doesn't have a clear course for policy. All policy makers really know at this point is that they are navigating a mid-cycle course correction. The Fed doesn't know how big that course correction will be, so it cannot and will not give market participants the certainty they desire.

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tim Duy is a professor of practice and senior director of the Oregon Economic Forum at the University of Oregon and the author of Tim Duy's Fed Watch.