Double pressure from Trump and the yield curve

We now see two additional Fed rate cuts, one in September and one in in October, versus our previous call of only one in September.

We continue to expect the Federal Reserve (Fed) to cut rates by 25 basis points on 18 September.

Instead of staying put at its 30 October meeting, we now think the Fed will use it to announce a further 25 bps cut, mostly due to the recent escalation of US-China trade tensions.

Those two additional cuts still fit within the Fed’s vaguely-defined ‘insurance’ framework, rather than as a bid to deal with an imminent recession.

President Donald Trump’s constant pressure on Jerome Powell is undoubtedly playing a role in the Fed’s stance, as is the Treasury yield curve.

The Fed still has to explain where ‘insurance’ cuts stop, and where ‘recession’ cuts start. Powell can cite the Greenspan playbook, especially the 1998 cuts (75bps of easing back then). We think Powell will try to remain voluntarily vague in the short term, wanting to see the effects of the Fed’s July rate cut on US data and markets.

A negative Fed rate scenario, one warranting much more accommodation than we expect, would come from a rise in the recession risk or a meaningful worsening of trade tensions. But this is not our central scenario.

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 force it to remain dovish.

We do not think the Fed is being influenced by the nascent debate about policy easing’s ineffectiveness. But we think there is implicit influence on the Fed from the debate about Modern Monetary Theory (MMT), which advocates low rates coupled with high budget deficits as a firewall against slow growth and low inflation.

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