We now expect the Fed to cut at all three remaining 2019 meetings – Our main takeaway from the July FOMC minutes is that the Committee is broadly comfortable with current economic conditions in the US, but that the downside risks to the outlook have grown significant enough for the Fed to make a ‘mid-cycle adjustment’ by lowering interest rates. The market reaction was rather muted, however, likely reflecting that the minutes come from a meeting that happened prior to the recent trade war re-escalation, and before more recent data – notably the ISM manufacturing PMI and Michigan consumer sentiment survey – suggest the economy is likely to lose further momentum in the coming months.
Indeed, following the recent re-escalation of the trade war, and our additional downgrades to global macro forecasts (see here), we now expect the Fed to cut at a quicker pace than previously – by 25bp at each of the three remaining 2019 meetings. Previously, we expected two more cuts by Q1 2020. In public commentary, Chair Powell has tacitly endorsed the notion that central banks with limited policy space should ease pre-emptively to avoid the need for more aggressive, unconventional easing measures to counter a severe slowdown or a recession. While overall growth in the US is holding up for the time being, the manufacturing sector is weak, and leading indicators suggest things will get worse before they get better. This is likely to hit the until-now more resilient consumer.
While we do not expect a recession as a base case, we do see a heightened risk of one, and we expect the Fed to act pre-emptively to counter this risk. At the same time, the Fed has clearly signalled that it is on a ‘mid-cycle adjustment’, rather than a prolonged rate-cutting cycle. This would imply to us no more than four rate cuts (including the one implemented in July). As such, we expect the Fed to pause following the expected December cut to rates, and to observe the effects of prior easing before embarking on any further stimulus. (Bill Diviney)