Balancing a Fed mid-cycle rate cut with markets

As expected by the Fed Funds futures market, the Fed cut interest rates by 25bps to a range of 1.75%-2.0% today.

Commenting on the data, Daniel Casali, Chief Investment Strategist at Smith & Williamson Investment Management, noted:

“The Fed has a difficult job to balance market rate expectations with what is required to sustain the business cycle. Back at the July interest rate setting meeting, Fed Chair Powell said that the interest rate cut was a “mid-cycle adjustment to policy” following the sharp slowdown in manufacturing and trade activity. The harsh reality is the rate cut was largely forced on the Fed as an insurance policy against a more broad-based downturn from President Trump’s trade protectionist agenda. The Fed made similar “insurance cuts” in 1995-96 and in 1998.”

“Looking forward, the Committee’s latest median interest rate projections indicate no further cuts for the rest of this year or for 2020. Given that there appears to be a dialling down in US trade war threats, that would seem appropriate.”

“Moreover, the economy probably does not appear to need a material shift in policy easing. US market interest rates are already low; a 30-year mortgage rate now costs a historically undemanding 3.5% per year. Job creation is healthy and wage gains are accelerating as the labour market tightens somewhat. Consumer confidence is high, inflation appears benign and fiscal policy is being loosened to support the economy.”

“The bottom line is that further significant rate cuts could end up being counterproductive if investors view the Fed as “panicking” over the state of the economy. If that were to happen, recession risk would then rise, and equity valuations would fall to discount this possibility.”

“Considering that much of the yield curve is negative outside the US, having positive interest rates should be viewed as a mark of a relatively healthy economy!”

Source: Thomson Reuters Datastream, Smith & Williamson Investment Management LLP (data correct as at 13th September)

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