Slowing US growth and risks are set to justify further cuts in coming months.
The FOMC delivered a second consecutive cut at their September meeting, taking the federal funds rate to a 1.75–2.00% range – a mid-point of 1.875%. Interestingly, there were three dissents to the decision, with James Bullard preferring a 50bps cut while Esther George and Eric Rosengren’s preference was to hold fire.
The revised ‘dot plot’ that accompanied this decision further emphasises that the FOMC are, overall, undecided on the outlook for policy.
By end-2019, seven participants believe a further cut to a mid-point of 1.625% will prove necessary, while five expect the FOMC to be on-hold from here. The other five members would rather the federal funds rate be 25bps higher. Come the end of 2020, only one more participant believes a 25bp cut to 1.625% will prove appropriate, whereas two more members than at end-2019 see the federal funds rate (at least) 25bps higher than today. This is in contrast to Westpac’s own view that another two cuts will be seen by year end, and be followed by two more in 2020.
How is the FOMC’s policy consensus likely to evolve?
Since the last forecast round in June, there has essentially been no change in the median and central tendency forecasts of the FOMC, with growth seen modestly above trend (1.75%) circa 2.0% over the forecast horizon and the unemployment rate broadly unchanged near the current 3.7% to end 2022 – below the longer-run ‘full employment level of 4.2%. As a result, inflation is expected to come back to the 2.0%yr target from 2021, on both a headline and core basis.
This view seems far too sanguine given the deterioration evident in US data, the escalation of US/China trade tensions since June and, more broadly, further clear evidence of a deterioration in global economic momentum. As alluded to by the unemployment forecasts above (and also on display in the decision statement), to see an above-trend outturn, the US labour market and growth in consumer spending must remain strong in the face of soft, weakening business investment and deteriorating exports.
History suggests a material divergence between business investment and the labour market is unlikely however. Indeed, at August, a material deterioration in the US labour market already looks to be underway, with average monthly job growth over the past six months of just 150k compared to 223k in 2018. While consumer confidence and spending arguably will hold up for a time, if this downtrend is sustained, a deterioration in household demand growth will be seen.
We anticipate this deterioration will slow annualised GDP growth back to trend in the second half of 2019, along with continuing weakness in business investment.
If the FOMC does not act to offset, GDP growth outcomes materially below trend in 2020 and 2021 are a clear risk. This would also make achieving the FOMC’s inflation objective (and hence the holding up of inflation expectations) very difficult.
Based on historic precedent and recent partial data, we continue to have strong conviction in our more pessimistic view of the US economy. We are also acutely aware of global risks. As Chair Powell (and we assume the Committee) see “high value” in sustaining the expansion, further action on rates is therefore likely in coming months, as growth expectations are revised down.
Indeed, Chair Powell was clear in the press conference that “history teaches us its better to be pro-active in adjusting policy” and that the “majority of the committee is going meeting by meeting”. His “main take away” on the policy outlook was that this is a committee that has “shifted its policy stance repeatedly and consistently”, in a data-dependent, risk-aware manner.
We therefore continue to anticipate that follow-up rate cuts will be delivered at the October and December meetings, and two more are likely at the March and June 2020 meetings as well – taking the federal funds rate to 0.875%. The risk to this view is that the FOMC becomes more reactive and the cuts therefore take longer to come through. Regardless, very clearly the US economic backdrop and balance of global risks argue for a sustained series of rate cuts versus the “mid-cycle adjustment” anticipated back in July.