President Trump was on the wires on Friday whinging about Fed Governor Powell’s performance;
“Frankly, if we had a different person in the Federal Reserve that wouldn’t have raised interest rates so much, we would have been at least a point and a half higher” referring to the pace of US growth. (I’m sure he has solid data behind that statement). Regardless of whether you agree or disagree with the President’s statement, investors are very clear in their expectation that rates are coming down, and coming down hard, over the next year (as evidenced by what’s been priced in the market). Economists, however, do not share this sentiment to the same degree.
As of the writing of this article, investors have priced in 70 basis points of easing by the end of 2019, and additional cuts in 2020. Contrasting this with a Bloomberg survey of forty-three economists, none of them expect a cut this month (the market is pricing a 25% chance of a 25 bp cut) and the median survey response pointed to a single quarter basis point cut in December. Sixteen of the forty-three economists that participated expect no change this year, and two are expecting a 25 bp hike this year.
Why the divergence in views?
The market (investors) seems to be reacting to the threat of escalating trade wars with the US’s major trading partners, assuming that these will materialize and slow down global growth, which will have a negative impact on the US economy. Therefore, they are pricing in aggressive cuts. Economists, who are notoriously cautious in their predictions, tend to take a wait and see attitude. Thus, they are looking for a less aggressive dovish stance by the Fed, as currently the evidence that the economy is at risk to justify significant easing by the Fed.
It’s important to remember that the Fed is run by economists who also take this same wait and see approach. Would the Fed be justified in taking a more gradual approach? Sure, assuming that a deal is struck with China. If, however, Trump imposes tariffs on the remaining $300 bio in Chinese imports, the Fed will grow increasingly concerned over global growth and more aggressive cutting may become necessary to stave off a US recession.
So, who will be right?
Trump has a reputation for making broad threats on his tweets and in the press, but then backing down when it comes to following through (look at the border wall, NAFTA, North Korea, tariffs on Mexican goods….). If this is yet another case of posturing, and the G20 meeting between Trump and Xi in Japan later this month actually takes place, the Fed will likely breathe a sigh of relief and wait to see how the data plays out.
Inflation will likely remain near the Fed’s 2% target (CPI has come down from 2.9% to 1.8% on the back of imported disinflation and the impact of the earlier build-up of inventories related to trade concerns but will likely level off as the trade negotiations will result in less cheap goods from China), PPI is at 1.8%, unemployment is running at a 50 year low at 3.6%, and GDP is running at 3.1%. That doesn’t sound like an economy that needs three interest rate cuts in 6 months to stave off disaster.
You’ve likely heard me say before that the Fed reacts to
the market and not vice versa, but in this case, I think
the market has gotten well ahead of itself, and the
economist view, which I usually take with a pinch of
salt, will be proven to be correct. Expect the market to
start backtracking on their expectations of 3 cuts this
year, unless Powell is far more dovish in the statement