On 23 Aug, US Fed Chairman Powell gave the keynote speech to an annual gathering of global central banks in Jackson Hole, in a time of concern that recession risk is rising and trade war is escalating. Under pressure from President Trump to cut rates soon and deeply, Powell did not offer a clear guidance on future rate cuts but emphasized that US trade policies are a big problem for Fed. We believe the escalating trade war and other global risks will compels Fed to cut rates more. We now expect Fed to cut 25bps in Sep and also see a growing prospect of another 25bps rate cut in Oct or Dec.
- Political and market pressure may force Fed to cut more. As the tariff on the remaining US$300bn Chinese imports will hit US consumption directly, trade war with China at this stage has become a much bigger threat to US economy and Fed’s aims to sustain the current economic expansion. To goose a slowing economy, Trump is now looking for more economic stimulus but he has very limited ammunition. Fiscal deficit has ballooned so another large-scale tax cut may not be feasible. Trump therefore counts on Fed to ease monetary policy sooner and more deeply, ideally cutting 100bp. On the other hand, markets are overwhelmingly expecting the Fed to follow up its first rate cut with more stimulus for the next meetings. Independent Fed still has to respond to Trump’s trade policies and market situations anyway.
- Fed rate cuts are about risk management, not current macro data. Every Aug, investors focus on what’s going on in Jackson Hole, hoping central bankers’ speeches to offer clarity on future policy paths. This year they had more reasons to do so. Fed cut interest rate by a modest 25bp in Jul to counter trade war, global weakness and low inflation, but since then many developments including US-China trade war escalation and US Treasury yield curve inversion will surely play heavily in Fed’s decision calculus. Although Powell did not explicitly promise when to cut rates in the speech, he did stress the unprecedented challenges brought by Trump’s trade policies to Fed’s policy framework, indirectly opening doors to more cuts in the near future. Now, Fed’s approach has been shifted from “data dependent” to “risk management”, which means that even solid US macro data could not change Fed’s path to more cuts to counter rising risks. The risks Powell mentioned in the speech also included growing possibility of a hard Brexit, rising tensions in Hong Kong and the dissolution of the Italian government. China’s announcement of retaliatory tariffs against US$75bn in US goods and Trump’s reactions surely made the situation even worse.
- We now see up to two more cuts by end-2019. Powell’s speech noted that rate cuts in the 1990s helped keep an expansion intact, when Fed lowered rates by 75bp within seven months in 1995 and three months in 1998 respectively to counter downside risks. They could be viewed as precedents for cutting rates rapidly in a short period of time. Powell did not mention ‘mid-cycle adjustment’ in his speech and we believe the escalating trade war and other global risks will compel Fed to cut rates more. We now expect Fed to cut 25bps in Sep and also see a growing prospect of another 25bps rate cut in Oct or Dec. Despite lower policy rates in the US, downside of US dollar remains limited as markets favor safe-havens. The global easing tide will leave China more room for monetary policy.
