Pacific Funds, September 2019

Fed’s rate cut intended to reassure uncertain markets

Informational commentary from Pacific Asset Management, manager of Pacific FundsSM Fixed-Income Funds.

Did the Fed’s Rate Cut Satisfy Investors’ Sweet Tooth for More Easing?

Key Points:

  • As expected, the Federal Open Market Committee (FOMC) cut interest rates for the second time this year, reducing the target rate range to 1.75%–2.00%.
  • Federal Reserve (Fed) officials made very minor language changes from their July 2019 statement, only changing language that centered around concerns of Chinese-American trade concerns and its impact on subdued business investment and exports, and household spending.
  • Two members voted to leave rates unchanged with one member voting to cut rates by 50 basis points.
  • Current chances of another rate cut by year-end is approximately 45%, according to Bloomberg.1

 

In the end, Fed officials met market expectations and lowered its benchmark rate by 25 basis points. Chairman Jerome Powell said the Fed was “carefully watching developments” and would “act as appropriate,” but did not elaborate on how the Committee is factoring in concern about Chinese-American trade in its rate outlook. Equities pared losses during the press conference after Chairman Powell suggested the Fed may need to expand its balance sheet to combat a liquidity shortage that has beset money markets during the past two days of the meeting. Dow Jones Industrial Average™ index finished the day 36 points higher as the odds of future cuts in October 2019 and December 2019 increased marginally according to Bloomberg. Below are the Fed’s language changes followed by our thoughts:

September 18, 2019 Statement July 31, 2019 Statement
“Although household spending has been rising at a strong pace, business fixed investment and exports have weakened.”  “ Although growth of household spending has picked up from earlier in the year, growth of business fixed investment has been soft.”

 

The Fed Dot Plot Chart showed seven Fed forecasters projecting at least one more rate cut for the remainder of the year, and median projections for 2020 and 2021 lowered from June 2019. The median projections for 2020 saw the federal funds rate remain at the 1.75%–2.00% range, while 2021 projections were for a federal funds rate between 2.00%–2.25%, and the long-run median projections saw two officials lower their outlook for the benchmark rate.

Other Projections

  • Gross domestic product (GDP) in 2019 was revised higher from 2.1% to 2.2%, while long-run expectations remained at 1.9%.
  • Unemployment is projected to move higher for 2019 from 3.6% to 3.7%.
  • Inflation expectations remained the same from June for core personal consumption expenditures (PCE) and PCE. Core PCE, which is the preferred gauge for inflation for the FOMC, was reiterated at 1.8%. Long-run projections for PCE remained at 2.0%.
  • 2020 projections were released showing GDP lower at 1.8%, and unemployment marginally higher at 3.9%.

Our Thoughts

It appears the overarching goal of the current rate cut was to ensure against trade uncertainties and not the start of a prolonged stance by the Fed. However, the Committee would continue to adjust its stance based off the evolving risk picture. The Dow Jones Industrial Average index and the S&P 500® index finished the day marginally higher. The 10-year Treasury bounced off session lows to finish the day nearly flat at 1.79% as Chairman Powell reiterated the Fed is working to sustain a favorable economy and the Committee would act as appropriate to sustain the current expansion. Chairman Powell also addressed recent pressures in overnight markets, mentioning that “it is certainly possible that we’ll need to resume the organic growth of the balance sheet sooner than we thought” in response to the liquidity shortage.

Fed language and economic projections remained consistent. However, three members of the Federal Reserve’s interest-rate setting committee voted against today’s decision. St. Louis Federal Reserve President James Bullard preferred to cut rates by 50 basis points. Meanwhile, Kansas City Federal Reserve President Esther George and Boston Federal Reserve President Eric Rosengren wanted to maintain the target range. With the July 2019 statement largely intact, and new economic projections almost completely unchanged, it may suggest that most Fed officials foresee a rebound in economic growth, making the probability of future rates cuts less likely. For the time being, the outlook for the U.S. appears favorable in the Fed’s eyes. The next meeting will be on October 29–30, 2019, and the final meeting of 2019 is set for December 10–11. Current chances of another rate cut by year-end is approximately 45%, according to Bloomberg.

Target Federal Funds Rate Dot Plot

fomc-chart-2

Source: U.S. Federal Reserve. The “dot plot” is a statistical chart consisting of data points plotted on a simple scale. Each shaded circle indicates the value (rounded to the nearest 1/8 percentage point) of an individual Federal Open Market Committee member’s view, where each participant at that particular meeting thinks the federal funds rate should be at the end of the year for the current year, the next few years, and the longer run. One participant did not submit longer-run projections for the federal funds rate, Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

 

1Source: Bloomberg Finance L.P., 9/18/19.

 


Definitions

One basis point is equal to 0.01%.

Core personal consumption expenditures (PCE) price index is the Fed’s preferred measure of U.S. inflation, which measures the prices consumers pay for goods and services without the volatility caused by energy and food prices.

The Dow Jones Industrial Average index (DJIA) tracks the share price of the top 30 large, publicly-owned U.S. companies which is often used as an indicator of the overall condition of the U.S. stock market.

The S&P 500 index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market.


Disclosures

This publication is provided by Pacific Funds. Pacific Funds refers to Pacific Funds Series Trust. This commentary reflects the views of the portfolio managers at Pacific Asset Management as of September 18, 2019, are based on current market conditions, and are subject to change without notice. These views represent the opinions of the portfolio managers and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector, or index, the offer or sale of any investment, or to predict performance of any investment. Any forward-looking statements are not guaranteed. All materials are compiled from sources believed to be reliable, but accuracy cannot be guaranteed.

All investing involves risk, including the possible loss of the principal amount invested.

Pacific Life Insurance Company is the administrator for Pacific Funds. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

PLFA3

Pacific Life Fund Advisors LLC (PLFA), a wholly-owned subsidiary of Pacific Life, is the investment adviser to Pacific Funds. PLFA also does business under the name Pacific Asset Management and manages certain funds under that name.

Bloomberg Finance L.P. is unaffiliated with Pacific Life Insurance Company, Pacific Funds, their affiliates, their distributors, and representatives.