via Timothy Moore
The US central bank will shift to cutting interest rates as soon as 2020, to counter a slowdown in growth as forecast by Capital Economics.
“Our long-held hawkish view that the Fed would be forced to hike interest rates twice in the second half of this year is now a firmly consensus view, even with a slim majority of the Fed’s own officials,” the firm’s three US economists, Paul Ashworth, Michael Pearce and Andrew Hunter, said in a nine-page report released last week.
“Where we differ from the markets and particularly the Fed itself now is in expecting an economic slowdown to force the Fed to begin cutting interest rates in 2020.”
The three economists said that their calculations suggest that second-quarter GDP growth in the US was “as strong as 4.5 per cent annualised”, reflecting a rebound in consumption growth and a big export-fuelled contribution from net external trade.
“It should be all downhill from here, however,” they said. “The [US] dollar’s recent resurgence and the retaliatory tariffs imposed by other countries will begin to weigh on exports from the third quarter onwards.
“Domestic demand growth will slow gradually, as the boost from the tax cuts fades and higher interest rates bite harder. By the second half of next year we expect GDP growth to be running at less than 2 per cent annualised, with growth slowing enough to prompt the Fed to begin cutting interest rates again in 2020.”
The report was released hours before the Fed’s latest Beige Book, which offers anecdotal information on current economic conditions across the US. The US government will release official second-quarter growth data on Friday.
In terms of overall economic activity, the Beige Book said 10 of the Fed’s 12 regional districts reported “moderate or modest growth”. The outliers were the Dallas district, which reported strong growth driven in part by the energy sector, and the St Louis district where growth was described as slight.
As for the outlook, the Fed said “manufacturers in all districts expressed concern about tariffs and in many districts reported higher prices and supply disruptions that they attributed to the new trade policies”.
All districts reported that labour markets were tight and many said that the inability to find workers constrained growth, the Fed also said.
CLEAR AND RISING RISK: PROTECTIONISM
TD senior economist Leslie Preston said the US economy is “at the mature stage of the economic cycle, with several pockets running up against capacity constraints”.
Ms Preston said the latest Beige Book bolsters the case for continuing to lift US rates, with the next move most likely in September. “Rising trade protectionism is a clear downside risk that the Fed is no doubt watching closely, but for now, the risk is not strong enough to forestall further hikes.”
There’s another reason why the Fed may continue to lift rates.
Attacks on the Fed’s policy path by Donald Trump could compel chair Jerome Powell to push ahead with rate hikes rather than ponder a pause, according to Greg Valliere, chief global strategist at Horizon Investments.
Mr Powell might feel the need to assert the Fed’s independence by continuing to lift and to show its resolve to check inflation too, Mr Valliere said.
In turn, President Trump’s position could “embolden” the policy doves at the Fed, Guggenheim Partners Scott Minerd said in a recent tweet. That could challenge the current consensus among policymakers and put markets on notice for a policy tact, at least.
Indeed, St Louis Fed boss James Bullard said in a speech on Friday that given “tame US inflation expectations”, he saw no need for the Fed to lift rates any higher right now, especially as that could increase the risk of an inversion in the yield curve as early as later this year. “Yield curve inversion is a naturally bearish signal for the economy,” Mr Bullard said.
For all the overall optimism about the US economy and corporate profits as the equity bull market nears record territory, there are signs that growth is somewhat less assured going forward than it has been. US housing starts have fallen to a nine-month low. Building permits declined in June, for a third consecutive month. Core retail sales also have been declining.
Of the 69 companies in the S&P 500 that have reported earnings for the June quarter, according to a Tematica Research comment late last week, 30 mentioned tariffs as a concern in their earnings call and 41 mentioned foreign exchange rates as an issue.
As debate about when the US economy will contract again gathers momentum – PIMCO’s global economic adviser Joachim Fels sees the potential for a recession in 2020 too – the data is holding for now.
The Atlanta Fed’s GDPnow model estimate for real GDP growth in the June quarter is at 4.5 per cent. The measure will next be updated on Thursday, the day before the official GDP data is released.
DoubleLine Capital CEO Jeffrey Gundlach last week tweeted: “Couple years ago Fed was on hold until data improved. Now Fed in quarterly hike mode ’til data weakens. But when that happens it’s too late.”