Should they cut or should they hold?
If they cut there will be trouble.
If they pause it will be double.
Tell me quick, I want to know.
Should they cut or should they hold!?

Pretty much everything has been said about whether the Fed should take out an insurance cut in the fed funds rate when their FOMC meeting concludes tomorrow afternoon. But not everyone’s had a chance to say it. So, I’ll briefly weigh in. My punchline: There are good arguments on both sides, but I’d hold for this meeting and signal forthcoming cuts as necessary. I’m not convinced that an insurance cut would have much upside relative to dovish forward guidance, and my bar for surprising the markets is high.

The case for a cut:

–Inflation is not only soft, but more importantly from the Fed’s perspective, inflationary expectations have slid down a notch. This is, by far, the most compelling reason to cut at this meeting.

–The May jobs report was soft and despite low unemployment, wage growth was flat.

–Real GDP is tracking at 2 percent, a downshift from recent prints of ~3.

–Here’s a sleeper issue that’s not getting enough attention even amidst all the chatter: fiscal stimulus is fading. where deficit-financed tax cuts and spending increases added 0.5-1 points to real GDP growth in 2018-19, as far as I can tell from following Congress’ appropriation debates (there will be spending; there will not be tax cuts), fiscal impulse will soon shift from positive to neutral.

–Trumpian trade tensions. They’re diminished given Trump’s reversal on full-bore Mexican tariffs, but trade policy, such as it is, is still a headwind.

The case for a pause:

–The strongest argument for holding is that the notion of “insurance cuts” is ill-defined and I’ve not seen compelling empirical evidence on their behalf.

–The May jobs report disappointed, but those monthly data are noisy and, even with some of the economic slowing noted above, the underlying labor market trends are still solid and, at least in the aggregate, U.S. consumers remain in decent shape. As I and co-authors recently wrote, there’s real turbulence beneath the aggregates, but the cyclical variables I track still look solid.

–For example, I find it useful to compare the product of jobs, weekly hours, and real wages (aggregate real earnings of production, non-supervisory workers) to real consumer spending (70 percent of GDP). In the figure below, you see the still-solid job market supporting pretty steady consumer spending.

Sources: BLS, BEA

–Financial markets place the probability for a cut coming out of this meeting at 20 percent. Now, I think surprising the markets can be a useful tool for the Fed, but there’s already enough uncertainty given Trump’s erratic trade mishegos.

–Given Trump’s badgering of the Fed to cut, in tandem with the pretty even case for pausing or cutting, there’s an independence case for the tie to go to the pauser.

So, while I certainly wouldn’t complain if a 25 bp cut in the funds rate comes out of this meeting, I expect the Fed to hold and can see their rationale. But it’s very important that they explicitly signal that their bias has shifted from patient holding to supportive cutting.