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Major Moves
The Federal Reserve Open Market Committee (FOMC) met today and left their main interest rate target unchanged. As usual, what the FOMC statement said is more important than the decision about the short-term interest rate which was already priced into the market.
The FOMC noted that growth measures have improved slightly but that inflation remains below the Fed’s target rate of 2%. It may sound strange that the Fed wants inflation, but most economists are much more worried about the negative effects of very low inflation (disinflation) or deflation.
Very low inflation numbers have been tough for the market because that tends to be correlated with low growth or expectations for slower growth in the future. Usually, if the economy is growing quickly, wages will rise and demand will drive up commodity prices; neither of those are happening now.
This seeming contradiction between low inflation and growth has been a tricky problem for economist and investors. The economy is growing and simultaneously sending signals through inflation that future growth may be weak. This is one of the reasons that investors are pricing in a rising probability for a rate cut later this year.
As you can see in the following chart from the CME Group (CME), the futures market is pricing in a 35.4% chance that the target rate will be 2.00-2.25% in October, rather than the current level of 2.25-2.50%. If you total all the probabilities in the chart, you will find that investors are pricing in a 44.2% chance of a rate cut by October.
Although it has been a long time since the Fed has lowered the target interest rate without a recession, it was fairly common practice in the 1980’s and 1990’s. In that sense, I wouldn’t suggest there is anything worrisome about a rate cut, but it also isn’t something that happens when growth is accelerating.
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