When assessing the state of the US economy, the data suggests that the Fed’s willingness to lower interest rates may not be fully justifiable
Written by Han Tan, Market Analyst at FXTM
As widely expected, the Federal Reserve has lowered US interest rates by 25 basis points on July 31, which is the first time the world’s most influential central bank has eased its policy settings in more than a decade. The Fed rate cut suggests that the US economic outlook has taken a negative turn, whereby the Fed has deemed it fit to cut interest rates just months after its December rate hike - the last in a series of nine rate hikes since 2015.
In explaining the rationale for lowering interest rates, Fed chair Jerome Powell once again cited the intensifying challenges surrounding global trade, as well as subdued US inflation. The aim for lowering interest rates is to ensure that economic growth momentum remains intact, while lifting inflation towards the central bank’s two percent target, which is a level the Fed has deemed to signal stable prices in the US economy.
Fed rate cut decision wasn’t unanimous
Yet when assessing the state of the US economy, the data suggests that the Fed’s willingness to lower interest rates may not be fully justifiable. Various economic indicators, including second quarter GDP, along with the numbers related to job creation, retail sales, and factory output, have exceeded expectations and point to resilience in the world’s largest economy. Hence there were a couple of Fed officials who voted against lowering interest rates in its latest July FOMC meeting.
Still, it appears that most Fed officials have seen enough warning signs to inject some measure of stimulus into the US economy.
Markets misjudged the scope of Fed’s bias
In the lead up to this key policy decision, global investors had forecasted multiple US interest rate cuts over the rest of 2019, with such expectations fuelling gains in global stock markets. Following Powell’s latest statements, markets appear to have overestimated the Fed’s willingness to lower US interest rates, with the unwinding of such forecasts resulting in a selloff in stocks.
Meanwhile, the Dollar Index (DXY) roared to its highest level since May 2017, breaching the 98.8 mark. The lowering of benchmark interest rates tends to result in currency weakness. In this instance, with US interest rates set to be lowered less than expected, that has allowed the Greenback to spread its wings and take full flight, at least for the time being.
What’s next for the Fed?
Although the end-July rate cut had been anticipated for weeks leading up to the decision, markets have been left perplexed by Powell’s post-meeting remarks. While indicating that policymakers are not about to embark on many more rate cuts, Powell also said that the Fed may not stop at just one.
Market participants who had been hoping that the Fed would use this end-July meeting to kickstart multiple rate cuts were left disappointed. Instead of receiving clear guidance from the world’s most important central bank, the Fed has fudged its policy outlook, leaving investors to ponder on what’s next on the central bank’s policy agenda.
Less-dovish Fed bolsters Dollar’s resilience while weighing on Gold, Oil, EM currencies
As markets digest the Fed’s latest signals, as confusing as they were, a less-dovish Fed over the coming months suggests that the stronger-Dollar is set to stick around for a while. The Dollar’s climb is also expected to make future gains harder to come by for commodities such as Gold and Oil, as well as emerging market currencies.
In the time leading up to the Fed’s next policy decision in September, investors will be scouring economic data and statements by Fed officials to predict what the US central bank will do next. Such expectations are set to have a large impact on the Dollar, with potential cascading effects on other asset classes, between now and September.
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