Job growth slowed to just 75,000 in May, well below estimates of 175,000, and job growth in March and April was shaved by 75,000. Treasury bond yields plunged on June 7 and expectations for the FOMC to lower the federal funds rate at or before the July 31 meeting rose to 70%.

The slowing in job growth reinforced the expectation that the FOMC may move as soon as the June 19 meeting, after Chair Powell said on June 4 the FOMC would act if necessary to sustain the expansion. The DJIA leapt by more than 500 points on June 4 in response to Powell’s comment. What should be obvious was undoubtedly a revelation for most investors. “EXTRA EXTRA Read ALL ABOUT IT! The Federal Reserve is monitoring trade developments and will respond if the economy falls apart!!"

The federal funds market is projecting that the FOMC will cut the federal funds rate by more than 0.75% in the next 12 months. The S&P 500 rallied to within 2% of its all time high on June 10 based on potential action by the FOMC and the suspension of tariffs on Mexico slated to go into effect on June 10. The Treasury bond market and the S&P 500 can’t both be right. If the FOMC lowers the funds rate by 0.75% or more by mid 2020, the economy and corporate earnings are going to be weaker than expected and rate cuts alone won’t be enough to save the day. If the economy proves more resilient than forecast, and President Trump doesn’t slap Chinese imports with additional tariffs, the FOMC won’t be lowering rates as much as bond or equity investors are currently expecting.

I think the odds of the FOMC cutting rates at the June meeting are less than 10%, although I acknowledge the quandary the FOMC is in. On one hand consider the economic fundamentals absent the trade issue. The Unemployment Rate remains at a 50 year low after the disappointing jobs report for May, while Unemployment Claims are hovering just above 50 year lows. Wage growth has eased a bit but is still near the highest level in a decade at 3.1% in May. The FOMC has clearly fulfilled its mandate for maximum employment.

The FOMC has a 2.0% inflation target, and depending on which inflation measure is used, the FOMC isn’t far from hitting it. While the traditional Core PCE rate was 1.6% in April, the Dallas Trimmed Mean Inflation Rate (TMIR) was 2.0%. As discussed in the June Macro Tides, the TMIR has been gaining sponsorship within the FOMC. “In recent weeks, Fed Chair Powell and Vice Chair Clarida have highlighted the TMIR, as have a number of district presidents, including Rosengren (Boston), Bullard (St. Louis), Kaplan (Dallas), and Williams (New York). Although all 12 Federal Reserve Districts are equal, the New York Fed is first among equals which makes William’s support noteworthy. The TMIR is far more stable than the PCE." In addition, the Core CPI rose to 2.1% in April. Although inflation isn’t precisely at 2.0%, it isn’t so far away as to justify a rate cut, or say that prices are not stable. The FOMC could look silly if they lowered rates preemptively only for trade talks to resume and prove successful requiring a rate hike before year end. The outlook for rate cuts is so broadly embraced that this whipsaw risk is never mentioned.

GDP growth has slowed to near 2.0% after growing 3.0% in 2018. Based on the current health of the US economy, there would be no discussion of a rate cut at the June meeting if trade wasn’t an issue. The current level of tariffs imposed by the US and China are estimated to lower GDP growth by 0.3% in 2019 which is not significant. The real risk is if tariffs are more than doubled in coming months. This would likely hurt growth by more than 0.6% as the psychological impact causes a bigger pullback by consumers and businesses from the increase in uncertainty and tension.

The FOMC wanted the peak in the federal funds rate for this business cycle to be higher than the current level of 2.4%, so they would have more leverage from lowering rates during the next recession. The FOMC has 10 bullets in its arsenal if they lowered the funds rate in 0.25% increments and fewer if they toss in a cut of 0.50% along the way. The dilemma is whether the FOMC would be wise to execute an insurance rate cut before they know how the trade negotiations will evolve, or wait until they know if the trade talks have failed. There are a number of reasons why I think the FOMC will wait. The G20 meeting is on June 28 and by not moving at the June 19 meeting they will know whether talks will be restarted or not. Although equity investors would be disappointed if talks are not resumed, the economic damage wouldn’t necessarily rise since existing tariffs wouldn’t change. By not acting at the June 19 meeting, the FOMC would learn whether the May employment report was a fluke or the beginning of a trend, since they would have the benefit of the June employment report on July 5.

There are two triggers that would spur the FOMC to lower rates: Additional weak data that confirms the economy is slowing more rapidly than expected or, President Trump levies tariffs on the $300 billion of Chinese imports not currently subject to tariffs. Another round of tariffs and retaliation by China would likely lead the FOMC to execute an insurance rate cut before economic data confirmed the anticipated weakness.