The Federal Reserve released the minutes of the July FOMC meeting today, revealing that only a thin margin of participants supported a rate cut at that meeting. The news failed to sway market participants from their belief that the Fed will cut rates again in September. Market participants are very much most likely correct on this point. At this point, the minutes have been overtaken by events.

The justification for the rate cuts had three parts: Decelerating economic activity tied to slower global growth and trade policy uncertainty, risk management associated with uncertainty to the outlook and limited policy space abroad to respond to slowing growth, and low inflation. The decision was far from unamimous as “several” participants wanted to hold rates steady given that the economy remained at a good place.  A few were concerned about the impact of easier monetary policy on financial stability.

On first blush, the lack of broad consensus on the reason for a cut or the need for a cut would seem to throw cold water on a rate cut in September. Still, market participants were unfazed by the news. I can’t say that I am surprised as circumstances have changed quite dramatically over just the past few weeks. I can see four reasons why the Fed will push through another rate cut in September even if some, like Boston Federal Reserve President Eric Rosengren, still resist such a move:

1. Trade policy uncertainty has risen. Almost immediately after the July FOMC meeting, President Trump announced additional tariffs on Chinese goods, escalating the trade wars. Trump subsequently backed off somewhat but tensions remain high and there doesn’t appear to be a resolution in sight. And we all kind of know that even if there is a resolution, another trade dispute will follow. In addition, we have  policy uncertainty that expands beyond trade. For instance, Trump flip-flopped on the need for additional stimulus such as a payroll tax cuts. He has instigated an international incident because he was quickly – and expectedly – rebuffed in his interest in purchasing Greenland. Eventually this kind of policy randomness will undermine business confidence.
2. Job market strength for last year was sharply overstated. The BLS today announced expected revisions to its nonfarm payroll estimates. For the twelve months ending in March 2019, the number of jobs will be revised down 501k, or, in other words, monthly job growth was 42k lower than believed over that period. This means that Fed rates hikes last year were predicated on an overly optimistic view of job growth as well as an overly optimistic view of the staying power of fiscal stimulus. The job market simply wasn’t as strong as was believed; the Fed should be thinking they need to correct for that error.
3. Easier financial conditions flow from expectations of Fed easing. This line from the minutes kind of said it all:
   

   Participants observed that current financial conditions appeared to be premised importantly on expectations that the Federal Reserve would ease policy to help offset the drag on economic growth stemming from the weaker global outlook and uncertainties associated with international trade as well as to provide some insurance to address various downside risks.Expectations of further rate cuts help ease financial conditions and offset the negative impact of slower global growth and policy uncertainty.

   Realistically, if the Fed pulls back on those expectations by cancelling the September hike – which is viewed as 100% certain – they likely trigger a substantial tightening of financial conditions as market participants react negatively with increased concerns that the Fed is willing to let the economy drift into recession.

4. Falling global rates and a stronger dollar. Falling interest rates around the world are helping to drag U.S. rate lower as well. I see Fed officials dismiss this as a “flight to safety” but that is exactly the point – if market participants are flying to safety en masse, then clearly something is happening that demands a Fed reaction. Falling global rates also suggest a falling r-star, which means that U.S. monetary policy is becoming tigher. The Fed needs to respond with lower rates. Finally, the dollar continues to gain strength, indicating tighter financial conditions as well as lower inflation. The Fed should respond with easier policy.

Bottom Line: At this point, I don’t really see that the Fed can walk away from a rate cut in September even if a substantial portion of FOMC participants would prefer to hold policy steady.

Note: I am on vacation for the last week of summer and postings will be light to nonexistent until the beginning of September.