The FOMC minutes from the September Fed meeting just crossed the wires, which revealed that central bank officials have mixed monetary policy outlook. FOMC participants deliberated the appropriate time end the recent string of rate cuts, as some argued that additional stimulus via interest rate cuts could further insulate the American economy from elevated risks – primarily due to weakness abroad – whereas others debated that the Fed could be taking out too much insurance against future shocks.

Several Fed members justified last month’s rate cut due to inflation readings still trailing below the Fed’s symmetric 2% target. Also, Federal Reserve staff noted that GDP growth forecasts face risks “tilted to the downside.” The US Dollar was little changed immediately following the release with spot USD/JPY – a particularly interest rate sensitive USD currency pair – holding onto earlier gains.

USD/JPY PRICE CHART: 1-MINUTE TIME FRAME (OCTOBER 09, 2019 INTRADAY)

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As previously noted, there is a material risk outstanding that the convergence between the market’s priced rate cut expectations and projections from Fed officials is expected to overwhelmingly drive price action going forward. The latest Fed dot plot indicated that FOMC members are virtually split between hawks and doves: 7 respondents see the target Federal Funds Rate (FFR) between 1.50-1.75% by the end of the year, whereas 5 respondents expect rates to remain unchanged at the current level 1.75-2.00% and another 5 estimate the FFR to range between 2.00-2.25%.

FED DOT PLOT – SEPTEMBER FOMC MIDPOINT TARGET LEVEL FOR FEDERAL FUNDS RATE (FFR)

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This compares to the market’s 92% probability currently priced in that the Fed will cut rates by another 25-basis points before year-end and a 52% probability of 50-basis points of cuts according to the latest overnight swaps data pulled from Bloomberg. There is a 78% probability that the FOMC will cut rates at its October Fed meeting.

FOMC INTEREST RATE RANGE IMPLIED PROBABILITIES (DECEMBER 2019)

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The recent repo market drama has drawn quite a bit of attention over the last few weeks as short-term funding pressures in the overnight lending market has forced the Fed to step in to alleviate stress by conducting open market operations. In short, this has resulted in the Federal Reserve expanding its balance sheet by nearly $200 billion since mid-September as it injects liquidity into the financial system by lending cash to banks with the short-term loan backed by Treasuries pledged for collateral.

The September FOMC minutes detailed that central bank officials have begun discussing a strategy around communicating its plans to “maintain an appropriate level of reserves,” which could be announced at the next Fed meeting. Markets have been told by Fed Chair Powell to not confuse the central bank’s latest series of cash injections with a restart of Quantitative Easing (QE), however. Specifically, Powell emphasized that “growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.”

POWELL SIGNALS FEDTO RESUME ORGANIC BALANCE SHEET GROWTH – BUT “NOT QE”

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That all said, the FOMC “will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion” with regard to future monetary policy decisions. Since the September Fed meeting, particularly disappointing PMI reports have spooked markets and raised the probability that America’s economy may soon slip into a recession, which has weighed negatively on risk assets. Although, the labor market remains solid despite job growth showing early signs of fatigue.

Nevertheless, in addition to keeping close tabs on upcoming trade talks between the US and China, traders will likely focus attention to the release of high-impact economic data later this week like inflation and consumer sentiment reports. In turn, seeing that Powell has stressed the point that the Fed will remain highly data-dependent and assess monetary policy decisions “on a meeting by meeting basis,” markets could be in store for heightened volatility.