This week, the Federal Reserve will be in the spotlight as markets digest where the central bank stands on this rate-cutting cycle. A CNBC survey of economists and money managers showed 80 percent of respondents anticipate another interest rate cut in October, and a narrow majority believes it will be the last rate cut of 2019. The Fed funds market — a key gauge of the direction of Fed policy — shows a 93 percent chance of a 25-basis-point rate cut.
Adding greater uncertainty to the mix is whether the Fed will provide greater transparency on its interventions in the repo market. The repo market — where banks turn to for cash to plug short-term holes in their balance sheet — has required a perpetual bailout since an unexpected interest rate shock in September. This Wall Street Journal video provides a good primer on the turbulence in the repo lending sector:
The Federal Reserve responded to the short-term interest rate shock by offering liquidity to drag interest rates back down — including the addition of over $100 billion to financial markets today alone. The Fed recently announced it would continue to extend this stimulus until January 2020, but since the central bank has already blown past its previous stop-point, some doubt the January target will hold. The Financial Times reports:
Some strategists have warned that this $60bn a month in purchases, along with repo operations, may not be sufficient to avoid funding pressures bubbling up at year end, when the demand for cash typically rises as banks step back from lending to the market ahead of important regulatory deadlines.
Expect Mr Powell to come prepared with a plan to keep enough cash in the markets at the end of December. And expect him to say, again, that the Fed’s interventions are about market plumbing, and not monetary policy.
The chart below shows how the Federal Reserve went from unwinding its balance sheet this year to building it back up.
Some market watchers have begun referring to the Fed’s repo market operations as “QE 4” — a branding Fed Chair Jerome Powell has sought to distance himself from. The first three rounds of quantitative easing are generally accepted as having failed to contribute to economic growth.
Is the Fed doubling down on QE? Or was the loosening of monetary conditions transitory? Either way, markets will be paying extra close attention to the Fed minutes this week. Let’s see if the Fed charts a clear path forward.
Photo credit: stantontcady via Flickr, CC BY-ND 2.0