Will the Fed cut rates?

Trade tensions and risks to global growth

The Federal Reserve (Fed) met last week and clearly telegraphed that it will no longer be “patient” and that it is leaning toward loosening monetary policy. Why? Fed Chair Jay Powell said trade developments and global growth concerns are on the mind of the central bank. As I look into the second half of the year, those two items are key to my outlook as well – and I believe the willingness of central banks to become more accommodative could be a positive development for stocks.

Is the Fed heading for a rate cut in July?

Last week’s meeting deepened the abrupt “about face” we first saw from the Fed in January. Recall that just last October, Powell suggested that rates were “a long way” from neutral. Then just last December, he insisted that balance sheet normalization would continue on “auto pilot.” But in January, the Fed abruptly changed its stance. It announced its plans to end balance sheet normalization by September 2019 and suggested it would be patient about its next rate decision – and that it could be a hike or a cut.

However, as the months passed, the market increasingly came to expect monetary loosening. And so last week’s meeting represented a significant deepening in the Fed’s dovish stance.

* “… the case for somewhat more accommodative policy has strengthened,” Powell said at his press conference on June 19.¹

* Fed Vice Chair Richard Clarida explained in an interview, “There was, I think, broad agreement around the table that the case for providing more accommodation has increased since our May meeting.”²

* Minneapolis Fed President Neel Kashkari, a non-voting member of the Federal Open Market Committee (FOMC) this year, wrote in a June 21 essay that the Fed should cut interest rates by half a percentage point, adding “I believe an aggressive policy action…is required to re-anchor inflation expectations at our target.”³

It seems clear that a rate cut is on the table for the July FOMC meeting.

But why? What is causing this continued march to more dovishness? In the past, members of the FOMC have suggested that they need to raise the inflation target, which justifies a rate cut without any deterioration in economic conditions – that is certainly what Kashkari suggested in his comments last week.

However, what we gleaned from the FOMC statement is that the Fed is concerned that the economy is slowing. The U.S. economy is growing at a “moderate” pace, according to the Fed in its official statement, which is a downgrade from the previous meeting, when the central bank characterized the economy as “solid” in its official statement. And so the FOMC “will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion,” the Fed’s statement said. Powell provided more colour during his press conference, explaining that, “It’s really trade developments and concerns about global growth that are on our minds… Risks seem to have grown.”⁴

The risk of trade wars is what we have been warning about for several years now. Powell pointed to the fact that uncertainty has increased, and business investment is slowing. As I have warned, economic policy uncertainty has historically depressed business investment, and it seems that history may be repeating itself.

Global central banks may loosen policy as well

The Fed is not alone. Last week the European Central Bank (ECB) signaled its interest in loosening monetary policy. Ditto for the Bank of Japan, which is looking for more tools that could help it become accommodative. And while the Bank of England has been talking tough, it cut its growth forecast for Britain’s economy to zero in the second quarter, highlighting risks from global trade tensions and growing fears of a no-deal Brexit.

And so the result has been that the universe of negative-yielding sovereign bonds grew last week to approximately $13 trillion, according to Bloomberg.⁵ However, this phenomenon is not limited to government debt. Bloomberg also reported that nearly a quarter of investment-grade credit is now negative yielding as well. ⁵

My outlook for the second half of 2019

Central banks’ dovish turn is shaping my outlook for the back half of 2019. I expect slower growth, as I don’t see an end to the trade wars. While stocks rose last week on news that U.S. President Donald Trump and Chinese President Xi Jinping will meet at this week’s G-20 meeting to discuss trade, I caution against any optimism. Nothing has changed that would suggest that China and the U.S. will reach a common ground; if anything, both sides are digging their heels in. One or both parties to negotiations might try to put a positive spin on the talks, but I believe it is highly unlikely that a trade deal will be reached any time soon – if ever during the Trump presidency. However, I believe that significant central bank accommodation should not only keep the U.S. and other major economies from going into recession, but should cause, in general, risk assets globally to outperform non-risk assets.

We also recognize the continued need to find diversified sources of income, as relying solely on traditional sources, such as government bonds, may not provide adequate retirement income in a low-yield world.

1. Source: Bloomberg, L.P., “Fed scraps patient approach and opens door to potential rate cut,” June 19, 2019
2. Source: Bloomberg TV interview, cited in The Wall Street Journal, “Fed’s Richard Clarida: ‘We’ll act as appropriate to sustain expansion,’” June 21, 2019
3. Source: Federal Reserve Bank of Minneapolis, “A strategy to re-anchor inflation expectations,” Neel Kashkari, June 21, 2019
4. Source: Washington Post, “U.S. markets mixed amid Iran tensions, G-20 anticipation,” June 21, 2019
5. Source: Bloomberg, L.P., “The world now has $13 trillion of debt with below-zero yields,” June 20, 2019

Important information:
Diversification does not guarantee a profit or eliminate the risk of loss.
Brexit refers to the scheduled exit of the UK from the European Union. In a “no-deal” Brexit, the UK would leave the EU with no formal agreement outlining the terms of their relationship.

Kristina Hooper is Global Market Strategist at Invesco. This article first appeared in the Invesco blog.

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Disclaimer

© 2019 by Invesco Canada Ltd. Reprinted with permission. The opinions referenced above are those of Kristina Hooper as of June 24, 2019. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.