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FOMC July’19 meeting Preview: Insurance rate cut certain, but what next?
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Market expects the Federal Reserve to cut the Fed Funds rate by 25bp to the 2%-2.25% range from the current range of 2.25%-2.50%. We never thought the chances of a 50 bp move were anything but negligible, though even at this late stage, the market appears to be pricing in about a one-in-five chance. 

The Fed is heading toward an interest rate cut for the first time in a decade with a fifty-year low unemployment rate at 3.7% in June, low inflation and above 2% GDP growth in hand. Even though Q2 growth slowed, the 2.1% pace, with more than a 4% surge in consumption, is above-trend growth, the Fed’s estimate of the non-inflationary rate. Under these circumstances, a 25bp cut from the Fed could be that reasonable ‘preventive measure’ to support the economy and to avoid a further slowdown amid ongoing US-China trade tensions

Given the dovish comments from various Fed officials over the past fortnight, Powell testimony earlier this month, the weakness in forward-looking indicators particularly for manufacturing, and the persistence of downside risks to the outlook – this has all led to consensus of a 25 bps rate cut.

However, it is one thing to take rate cut as an insurance policy under current conditions, but things are not so straight forward. It seems clear, for example, that most of the slowdown in China is not related to the trade tensions. Unless the decline in the fed funds target rate translates to lower consumer borrowing costs (e.g., credit cards, student loans, car loans), it is not obvious how a Fed cut will make up for the loss of aggregate demand.

Nevertheless, the Fed is determined not to break its easing pattern, and we expect three rate cuts by the end of Q1 CY20.  While several other major central banks are likely to ease policy over this period, the US has scope for deeper cuts.  The rotation of votes among the regional Fed presidents will likely see a somewhat more dovish cast to the FOMC.  Alongside the cut on July 31, we expect the Fed will also stop its balance sheet unwinding six weeks earlier than it had anticipated avoiding any confusion on the easing cycle among market participants.

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