Complex Made Simple

Here’s why you need to watch the Fed moves this week!

Keeping one eye on the trade standoff between the U.S. and China and the other on signs of a global economic slowdown, the Fed has a crucial decision to make!

A recent WSJ survey shows that a majority of leading economists expect the Fed's next move to be a rate cut The U.S.-China trade war is takings its toll on both the economies, with recent economic data raising eyebrows Markets are bracing for short-term corrections on projections that a rate cut is due through the next 3 months

The U.S. Federal Reserve hiked rates four times in 2018, taking the total to nine rate hikes since it began normalizing rates in December 2015 – but times are changing. Despite shifting to a slightly dovish tone late last year, most officials and economists projected a minimum of two rate hikes for 2019 at the start of the year. 

Six months later – Wall Street and leading economists are predicting that instead of raising the rates or even holding off on tightening measures, there's a possibility that the Fed could cut rates for the first time in more than 10 years – and this could happen very soon – even as soon as Wednesday. A recent WSJ survey shows that a majority of leading economists expect the Fed's next move to be a rate cut.

What changed?

The Federal Reserve has been closely following the trade standoff between the U.S. and China. It has also been keeping a close watch on signs of a global economic slowdown.

At the end of the last Fed meeting, which was held between April 30 and May 1, Fed Chairman Jerome Powell made it clear that there was no hurry to hike rates despite the U.S. economy demonstrating signs of strengthening. "In light of recent, softer inflation readings, some viewed the downside risks to inflation as having increased," the minutes of the meeting read in May. Yet, it's important to note that at the time, the U.S.-China trade war appeared to be nearly resolved.

However, everything changed again when U.S. President Donald Trump escalated the trade standoff by raising tariffs on $250 billion worth of Chinese goods, threatening 25 percent or "much higher" on a further $300 billion. China retaliated by increasing levies on $60 billion worth of U.S. goods. 

While on one hand, the trade war is having an adverse effect on the Chinese economy, with a looming current account deficit, lower-than-expected industrial output, slowing fixed-asset investment, and a weakening GDP sounding alarm gongs; on the other hand, the U.S. is also beginning to show signs of a softening economy. The recent jobs report indicating a slowdown in gains, increasing costs for families, and a slowing GDP signal the need to prop up the U.S. economy. 

The Fed has, therefore, had to backtrack on the hawkish stance that it adopted over the last few years in its effort to boost employment and curb inflation. The Fed is due to meet again on Tuesday, June 18, and Wednesday, June 19 for its Federal Open Market Committee meeting. While many, including St. Louis Fed President James Bullard, have stated that a rate cut is needed "soon" as a form of "insurance" against a steep slowdown, there are others who believe that the Fed will remain dovish without needing to go through with a rate cut.

No rate cut in June?

There are optimistic investors, as well, pointing to positive signs in the U.S. economy such as improved consumer spending figures, higher-than-expected retail sales and industrial production data, and stronger-than-expected first quarter earnings in 2019 despite the trade tensions causing volatility in the markets. However, given the overall sentiment, the market is bracing for short-term corrections on the expectation that rate cuts are due sometime through the next three months.

There's also the fact that President Trump is expected to meet Chinese President Xi Jinping at the G20 summit in Osaka, Japan at the end of the month. This brings in the possibility that the Fed could hold off on the rate cut, and agree to leave rates unchanged until then. Additionally, the Fed has been attempting to avoid reacting directly to market and political pressures in order to maintain its own credibility; it has constantly reiterated that decisions will be taken on its own data rather than giving into to external pressures. If the Fed remains cautious and stays away from a rate cut this month, it would also help it add a little more distance from the December rate hike – making it look less like a U-turn in its policies. The federal funds rate – the interest rate on overnight loans of bank reserves that the Fed controls – is currently set in a range of 2.25 percent to 2.5 percent.