In view of strong employment growth in the US, the Fed will probably lower interest rates than expected by financial markets in the rest of 2019, says Fitch Ratings. A 25bp reduction now appears likely either at the July or September FOMC, but unlike current prices on future Fed funds markets, the start of a set of interest rate cuts is unlikely.
Dovish Fed President Powell’s Congressional testimony last week indicates that a reduction in interest rates is probable in late 2019. The remarks by Powell include a surprising emphasis on low inflation, as several key inflation indices stay about 2%. He also indicated, after the Fed meeting in the middle of June, that downside risks to US growth had remained as a consequence of the global expansion and trade policy uncertainties.
GDP has increased faster than potential by 1H19, consumer spending is solid and employment growth is strong in a historically tight labor market. In addition, US employment growth is stronger. The next cut appears therefore to be a policy move to reduce downside risks instead of a data-driven policy response. In the light of rising trade policies, investment in companies is slowing and the production output fell; but, according to the Fitch June ‘ Global Economic Outlook,’ US GDP is still likely to grow by 2,4 percent in 2019 before it will slow to 1,8 percent next year. The projections of the Fed themselves indicate a similar, higher trend in the combined growth rate over 2019 and 2020.
In this case, instead of embarking on a sequence of rate reductions, the Fed appears most likely to cut prices once by 25 bp in 2019 and then to leave prices to stand until 2020. The Fed would undo nearly all of the tightening in effect by 2018 due to the three price cut prices presently on future markets by the end of 2019, which seems very unlikely unless the US economy decreases considerably further than we and the Fed anticipate at the moment.
A further sharp rise in trade between the US and China could lead to a sharper financial downturn in America. But under these circumstances, the detrimental effects of trade policy disruptions in US exports, business investment, and real wages could really be compensated by much lower interest rates.
Under the background of the recent rise of investor search for returns, federal relief, less aggressive than anticipated by financial markets, could generate some market volatility. If market players believe that central banks will continue to reduce rates to support both the economic activity and asset prices (including’ the Fed’), then the risk will be that the prices of financial assets will become especially sensitive to surprises in central-bank policies.