The Fed: An Ounce of Prevention

June Meeting Analysis

The Fed: An Ounce of Prevention

Wednesday's Fed statement makes a rate cut in July the base case for investors, with a 25-basis-point move most likely.

Dovish Signals

The Fed did not cut rates or change its balance sheet policy yesterday, but that hardly mattered. The Fed was dovish in every other way that counts, from the statement to the dots to the press conference. Fed Chair Jerome Powell communicated a clear path for cutting rates later this year, and even leaned into a cut at the July meeting as a strong possibility. The market responded accordingly, with Treasury bonds rallying (led by the 2-year point on the curve), investment-grade credit tightening and the US dollar weakening.

The details of yesterday’s dovish message included the following: The post-meeting statement replaced the word “patient” with a commitment to “act as appropriate to sustain the expansion.” The statement also flagged the decline in breakeven inflation by saying “market-based measures of inflation compensation have declined” (previously these had been characterized as “low”). While the median dot for this year remained unchanged, there were eight FOMC members who anticipated a cut and seven of those eight members anticipated two cuts this year. Powell then amplified the message from the dots in his press conference by saying that even the FOMC members with unchanged dots “agree that the case for additional accommodation has strengthened since our May meeting.” Throughout the hiking cycle the dots were used to guide future hikes. Yesterday that got flipped on its head and the dots were used to guide coming cuts.

Powell began his press conference with an extended discussion of low inflation and the challenges that it causes. A shout out to Western Asset's Mike Bazdarich, whose well timed analysis on Tuesday correctly anticipated that low inflation would in fact be the cause of a Fed ease later this year.

 

 
A Notable Shift

Powell’s remarks on inflation included a very notable shift from the May press conference language, where he dismissed low inflation as “transitory.” In fact, Powell tried to distance himself from his own May comments by saying “Let me say on inflation, it's something I've been concerned about for quite a long time…So, I think you know, we certainly don't want to be seen as weak on inflation, and I don't believe we are.” I’m not sure that’s totally right, and it’s weirdly inconsistent with him admitting earlier in the press conference that breakeven inflation has fallen. Anyway, chirping aside, Powell was clear on low inflation being a rationale to ease policy. Something like this will indeed be the foundation for a cut, when that cut happens.

The Fed Chair further bolstered the logic for a rate cut by emphasizing risk management. The following line was especially striking: “Research shows that it’s wise to react, for example, to prevent a weakening from turning into a prolonged weakening. An ounce of prevention is worth a pound of cure.” This was in the context of his concern that proximity to the zero lower bound limits the amount of policy response, which in turn heightens the desire of policymakers to not have the downturn in the first place. This strikes me as exactly correct. Fed officials are nervous about whether they could do enough in a recession, so much better to avoid having to find out by running policy easier today.

With a rate cut all but set, and a high likelihood of that cut coming in July, the remaining question is whether the Fed will cut 25 or 50 bps to start. Based on yesterday’s news, a 25 bps cut is probably more likely to start. In his dissent yesterday, St. Louis Fed President James Bullard said he would prefer a 25 bps cut. Bullard is the dove on the committee. If Bullard is calling for a 25 bps cut, who would be advocating a 50 bps cut? Moreover, Powell cautioned against overreacting; and the desire to wait for more data doesn’t exactly suggest a Fed that is chomping at the bit to make a bold statement. Finally, “an ounce of prevention” sounds small-ish in size, at least to me. So, I think they start with 25 bps. If the economic data collapses in the next six weeks, or if trade risks escalate, then they have the option to move up to 50 bps, but that’s not the base case at the moment.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.