Why Is Wall Street So Sold on the 50-Basis-Point Rate Cut?
July 19 2019 - 2:26PM
Dow Jones News
By Akane Otani
One of Wall Street's most eventful debates centers on a subject
that many investors, analysts and Federal Reserve officials appear
to consider closed: whether the central bank will cut rates at its
two-day meeting ending July 31 by a quarter of a percentage point,
as widely expected, or a half a point.
The debate sprang into view this week after John Williams,
president of the Federal Reserve Bank of New York, said central
banks should "move more quickly to add monetary stimulus" than they
otherwise might. The comments, which the Fed later said weren't
intended to apply to the current debate, fueled a rally in U.S.
stock indexes and a spike in derivatives that measure traders'
expectations for Fed rate moves. President Trump said Friday he
agreed with the remarks.
The market on Thursday was pricing in as high as a 71% chance of
the Fed lowering its federal funds rate by 0.5 percentage point
after its July 30-31 meeting, according to CME Group. That was the
highest odds this year. The bet is raising the eyebrows of many
investors, given the broad consensus that the U.S. economy is
generally healthy and officials' typical preference for moving
deliberately in cutting rates.
On Friday, the price of eurodollar three-month continuous
contracts, retreated to $97.930 after briefly climbing to $97.980
following Mr. Williams' remarks. The contract's price typically
rises when rates fall.
And there were few signs that traders were suddenly jumping into
the rate markets. As of Thursday, open interest for eurodollar
futures -- or the number of futures and options contracts
outstanding -- stood at around 13 million contracts, according to
CME Group. That was up just slightly from 12.9 million contracts at
the end of last week, according to CME Group.
The data suggest that traders, investors and analysts remain
unconvinced that, absent a perceived emergency, the Fed would lower
rates that quickly.
"When you look at the data, going more than 25 [basis points, or
hundredths of a percentage point] is a head-scratcher," said Kevin
Giddis, head of fixed income capital markets at Raymond James, in
an email. Among economic indicators, "there just aren't that many
of them that appear to be getting weak enough to warrant this
move."
UBS and Morgan Stanley are among the few investment banks that
expect the Fed to lower rates by 0.5 percentage point at the end of
the month. Analysts at Goldman Sachs, JPMorgan, Citigroup, Bank of
America, Deutsche Bank and Barclays, among others, expect the Fed
to make a 0.25 percentage point cut in July.
Those who believe the Fed will make a deeper rate cut say that,
with interest rates already at low levels, the central bank has
less room to move rates slowly to stave off an economic downturn.
That is why Mr. Williams said Thursday that "it pays to act quickly
to lower rates at the first sign of economic distress."
Those who are skeptical point to a statement from the Federal
Reserve Bank of New York late Thursday that appeared to walk back
Mr. Williams' comments. The official was making an "academic
speech," not commenting specifically on potential policy moves at
the upcoming Fed meeting, a spokesman said. Mr. Trump said he liked
the first comments better.
Skeptics also argue that while the U.S. economy is slowing, it
is not weakening fast enough to warrant a 0.5-percentage-point rate
cut, one that might risk echoing some of the Fed's emergency
actions during the 2007-2008 financial crisis.
After a string of better-than-expected economic reports, the
Federal Reserve Bank of Atlanta's GDPNow model estimates gross
domestic product will increase 1.6% in the second quarter, compared
to estimates of as low as 0.9% in May.
If anything, the Fed is likely to make a 0.25 percentage point
cut -- but no bigger -- to effectively "reverse" its December rate
increase, said Art Hogan, chief market strategist at National
Securities. The scale and timing of future rate cuts will depend
heavily on economic data in the months to come, Mr. Hogan
added.
Others say that even if Federal Reserve Chairman Jerome Powell
was leaning toward cutting rates by 0.5 percentage point, it could
be difficult to persuade his colleagues.
Comments by other policy makers, including St. Louis Fed
President James Bullard and Kansas City Fed President Esther
George, suggest they don't see the need for that kind of aggressive
action.
"If Powell and team are going to go for 50, there's going to be
a lot of dissents," said Andrew Brenner, head of global fixed
income at NatAlliance Securities. "They're probably willing to
accept one, but not three."
--Daniel Kruger contributed to this article
(END) Dow Jones Newswires
July 19, 2019 14:11 ET (18:11 GMT)
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