Fed View: Bullard hints at rate cut later this year – St Louis Fed President James Bullard made headlines overnight and this morning with a number of comments suggesting an increased willingness to support rate cuts. He said that the Fed ‘may have overdone it’ with the December rate hike, that a rate cut would be ‘an option’ if inflation continues to disappoint, and that he ‘wouldn’t rule out’ such a move later this year. While markets have understandably focused on these comments, Bullard also remarked that ‘rates are in a good place right now’ and that it would be ‘premature’ to contemplate a cut at present. Bullard is a voting member on the FOMC this year, but he is also a prominent dove who repeatedly argued against the rates hikes of 2018. As such, it is hardly surprising he thinks the Fed might have overdone it with rate hikes, and comments from NY Fed President John Williams (essentially toeing the ‘wait-and-see’ line of Chair Powell) suggests the broader FOMC remains comfortable with current policy settings – at least for the time being.
Confidence declines or a tightening of financial conditions could trigger a cut – Following the re-escalation of the US-China trade war, and against the backdrop of continued inflation undershoots, market pricing of Fed rate cuts has increased further over the past couple of weeks, from roughly 15bp of cuts priced by year-end in early May, to 26bp (i.e. a full cut) as of today. We expect policy to remain on hold on our forecast horizon (to end 2020). Growth is likely to remain solid – particularly consumption – and while inflation is subdued, we expect it to recover back to target by September as some of the temporary factors weighing on inflation fade. With that said, the re-escalation of the trade war poses downside risks to the growth outlook, and could have a substantial impact on financial conditions and confidence over the coming months, which could in turn prompt a shift at the Fed. We expect the manufacturing sector to weaken further – signalled by the fall in the ISM new orders index – as the US continues to play catch-up with the global industrial slowdown. However, this alone is unlikely to prompt a shift on the Fed. Rather, we believe a broader decline in business confidence – i.e. also in the services sector – and likely consumer confidence (which remains elevated), would be necessary. Another potential trigger would be a significant re-tightening of financial conditions – i.e. sharp equity market falls. Such market weakness would need to be at least on the scale of what happened last October, if not bigger. We remain some way from fulfilling these conditions, but much will depend not just on developments in the trade war itself, but in how business, consumers, and investors react to these developments in the months ahead. (Bill Diviney)