JULY FED MEETING REVIEW

The Federal Reserve cut rates by 25bps on 31 July for the first time in 10 years. We continue to expect another rate cut in September.

As expected and as telegraphed, the Fed cut rates by 25bps on 31 July – the first rate cut since December 2008 – and it ended prematurely its quantitative tightening programme (in August instead of September).

Chairman Jerome Powell justified the rate cut as an “insurance” cut, i.e. to insure against the downside risks to US growth, mostly coming from weak foreign growth affecting US manufacturing and investment. He also cited below-target inflation.

He also implicitly cited the ‘recalibration’ ground, as the theoretical ‘neutral’ rate is falling and equilibrium unemployment is lower than previously thought.

Particularly interesting were Powell’s references to past episodes of ‘insurance’ easing, particularly Chairman Greenspan’s 1995 and 1998 rate cuts. From September 1998 for instance, the Fed cut rates three times, over three months (Powell also noted that the Fed ended up hiking again later, indeed in June 1999).

He further emphasised this easing is not the start a long rate-cutting cycle, as he sees no recession in the pipeline (rather, he noted the “resilience” of the US economy). It’s a “mid cycle adjustment”, he highlighted. This was perhaps the most important line of his press conference.

Overall, we feel that Powell left the door open for another ‘insurance’ rate cut. Such additional easing could come as soon as the next meeting in September (this was and remains our scenario).

A negative Fed rate scenario warranting much more accommodation than we expect would be indeed if a recession struck (still not our scenario), or if trade tensions meaningfully rose in the coming weeks, like a breakdown in trade talks with China. But as Powell noted, the trade talks seem now to have “returned to a simmer”.

From a fundamental perspective, we continue to think the Fed is in a “debt dominance” regime, where high private debt will constrain the Fed’s actions, and we doubt the Fed can indeed hike again as it did in 1999. Times have changed, and there is much more debt in the system now, and the Fed’s balance sheet is much bigger.

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