Fed update – Driving under the (political) influence
We now see a 25bp cut on 31 July (versus in December in the main scenario prior), followed by another 25bp cut on 18 September.
- The role of politics including President Trump’s pressure to cut rates (and his call to dismiss Powell) and the anxiety ahead of the G20 summit on 28-29 June – particularly the crucial Trump-Xi meeting – has been even more impactful than we expected (we were wrong!), leading Chairman Powell to signal more firmly an imminent rate cut.
This political noise adds to the underlying dovish picture that has prevailed since January 2019. The Fed has been prioritising the extension of the US business cycle and with more focus on (or targeting of?) financial markets as a way of buttressing both consumer and business confidence to support consumer spending and business investment. This rhetoric was again on full display during the press conference.
We now see a 25 basis point cut on 31 July (versus in December in the main scenario prior), followed by another 25 basis point cut on 18 September.
The bar not to cut in July is high, and it would take, in our view, a sizeable trade ‘deal’ with China, for instance implying the removal of existing US tariffs on Chinese imports and various impediments to China’s tech sector. Such a watershed deal before end-July is a tall order. By contrast, a total breakdown in the trade talks could lead to more monetary accommodation in coming months than in our central scenario.
The risk in the medium term is where the Trump-Fed feedback loop may lead us; such injection of politics in the Fed policy is highly unusual. When in doubt, Powell has shown that the path of least resistance is to be dovish if not ease, and this could indeed be the medium-term risk, especially as the general focus is already shifting to the November 2020 elections.
The Fed may indeed succeed in keeping the US business cycle alive for longer; low corporate bond spreads could support corporate margins, and low mortgage rates could help revive the housing sector. Furthermore, recent good news has come from the pick-up in labour productivity – dovishly ignored by the Fed.