FOMC Preview: Repo Wreckage Unlikely to Derail Fed’s Plans for a 25bps Cut
Matt Weller, CFA, CMT September 18, 2019 2:15 PM
We would be shocked if the communication-era Fed failed to cut rates.
Despite growing pressure from President Trump, the market-implied odds of a 50bps double rate cut at today’s Federal Reserve meeting have fallen to essentially 0%. In fact, a single 25bps interest rate cut is “only” 95% priced in according to data from Bloomberg, though we would be shocked if the communication-era Fed failed to cut rates after regularly hinting at such a move for weeks.
As the graphic below shows, inflation (Core PCE) remains stubbornly below the central bank’s 2.0% target, even while the unemployment rate sits at a half-century low. Meanwhile, the current trade war “ceasefire” between the US and China has put one of the global economy’s biggest potential stumbling blocks on hold for the moment:
Source: TradingView, FOREX.com
Beyond the “decision” about interest rates, recent developments in the money market sector have made this Fed meeting interesting. Over the last week, the interest rate on repos, a key short-term funding mechanism for banks, have surged. In response, the Federal Reserve has reintroduced its own repo facility, essentially injecting money into the banking sector. While most analysts believe the situation is due to a transitory confluence of one-off factors, we expect Chairman Powell to field multiple questions about the repo market in his post-decision press conference. At the margin, these issues may increase the likelihood of a tweak to the IOER, or interest on excess reserves, paid to banks to encourage more lending, or a standing repo facility, which would be viewed as slightly dovish developments.
Potential Market Reaction
With a 25bps cut widely expected, the decision on interest rates is unlikely to be a big market mover in and of itself. Instead, stock and dollar traders will be keeping a closer eye on the central bank’s outlook for rates and the economy moving forward.
If Chairman Powell and company cut their forecasts for interest rates (the infamous “dot plot”) and/or inflation for the coming years, traders will view that as a “green light” to anticipate more than a “mid-course correction” to interest rates. In that case, we could see the dollar fall and US indices rise.
On the other hand, a more optimistic outlook that downplays the potential for an economic slowdown would prompt traders to trim their bets on further interest rate cuts from the central bank. In that case, the greenback could catch a bid, while US indices would likely pull back further from their record highs.
Disclaimer: The information on this web site is not targeted at the general public of any particular country. It is not intended for distribution to residents in any country where such distribution or use would contravene any local law or regulatory requirement. The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
Futures, Options on Futures, Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Losses can exceed your deposits. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex and commodity futures, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that we do not provide any investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. References to Forex.com or GAIN Capital refer to GAIN Capital Holdings Inc. and its subsidiaries. Please read Characteristics and Risks of Standardized Options.