This week the Federal Open Market Committee (“FOMC” or “Committee”) eased policy for the first time in over a decade, lowering the target range for the federal funds rate by 25 basis points and ending balance sheet run-off a bit earlier than previously signaled. The decision and related communications caused a tightening of financial conditions, with the Treasury curve flattening, stocks declining and the dollar appreciating against a range of currencies. Some tightening in conditions after a modest rate cut was to be expected, given that markets assigned non-negligible odds to a larger policy move. Still, the market reaction also reflected disappointment with the message in the policy statement and in Chairman Powell’s press briefing. Indeed, the Committee was trying to strike a delicate balance―specifically, signaling an easing bias regarding the outlook for future policy, while also pushing back on market expectations that this first rate cut would signal the beginning of a prolonged easing cycle.

The attempt to strike this balance could be seen in some of the revisions to the policy statement. For example, the Committee will “continue to monitor” incoming information on the outlook, as opposed to “closely” monitoring, as was the case in the June policy statement. In addition, the Committee used a relatively weak word, “contemplate”, to describe its process for determining the future path of interest rates. These language changes are likely intended to signal no great urgency to cut rates further. Chairman Powell pursued a similar balancing act in his press briefing, stressing a positive baseline outlook for the economy and describing the rate cut as a “mid-cycle adjustment”.

Looking ahead, we believe the Committee is still very likely to cut rates further, and probably more than once. As we wrote recently, against a backdrop of weak inflation and a depressed neutral policy rate the policy stance had become overly restrictive after last December’s rate increase. Thus we are skeptical that a single insurance cut will provide enough support to the economy in the presence of weaker global growth and ongoing risks from US trade policy. In addition, despite market hand-wringing regarding Powell’s performance in the press briefing, the Committee still maintains a clear easing bias. Powell also referenced the mid-cycle insurance cuts of the late 1990s―both of those “mid-cycle adjustments” totaled 75 basis points of policy easing. Finally, the reasons for cutting rates―slower growth, downside risks stemming from a weak global environment and trade tensions, and muted inflation―are all likely to remain in place in the months ahead.

The FOMC may have regained some optionality in this week’s policy decision and communications, but this is not a free option. Some of the improvement in data as of late stems from the significant easing in financial conditions since early January, when the policy bias first began to shift from tightening towards easing. To the extent that recent communications undue some of that easing of conditions, the improvement in data may prove short-lived. In addition, continuing dollar strength increases the risk that the Trump administration will turn towards foreign exchange intervention. Such a development would raise risks to the Federal Reserve’s credibility and independence – the Committee would need to decide whether to commit the Federal Reserve’s own funds alongside the Treasury in what would likely be an ill-conceived and ineffective attempt to weaken the dollar.