Back to Blog feed

What Would it Take For the Fed to Cut?

4 June 2019 by Mark Holman

With markets now pricing in two cuts in the Fed Funds rate this year, and a 97% chance of at least one cut, once again the FOMC members are at odds with the financial markets.

Not a single member, voting or otherwise is calling for a cut any time this year. Fed watchers out there may point to Bullard’s comments yesterday as being the first from an official to call for a cut, but his reference was entirely conditional. The FOMC are currently all singing from the same hymn sheet, claiming that it would take a sustained period of inflation undershooting the target before a cut became necessary, and that consequently they are all happy with the wait-and-see approach. Consequently we think something fresh or unexpected is required for the Fed to move sooner, and in line with what markets expect.

We think the most likely such event to cause the Fed to act is a tightening of financial conditions arising from broader turmoil in financial markets. The Fed may then seek to neutralise this tightening with a loosening of monetary policy. This is what Bullard was referring to indirectly yesterday. Quite clearly, Q4 2018 acted as a tightening of financial conditions, and perhaps had the effect of at least one 25 basis point rate hike, albeit temporarily as it turned out. The cause then for the turmoil was the coordinated global economic slowdown coupled with the possibility of a Fed policy error. What could be the cause now?

Well, global economies are still slowing, so this dynamic is still in place, and to some extent there is the same issue with the divergence between the Fed and market expectations on rate policy. However, what is driving market sentiment alongside this is the reignition of the trade war. Now it is not just with China, as President Trump on Friday brought Mexico into the frame, and on Monday declared India was no longer an emerging market and would not have the same access to trade terms with the US. On top of this, there is unfinished business with Europe on the automotive sector and talk of issues with Australian trade terms too.

So the market’s foregone conclusion that the trade talks will all be resolved peacefully with no collateral damage is far from reality. The global trade war is alive and kicking and has the potential to drag on or escalate. Treasury markets are clearly pricing this in, but equity markets are still taking a more sanguine view.

We are certainly not saying our base case is another period like Q4 2018, but a more volatile summer could be ahead and a severe correction could be the catalyst for the Fed to move from stick to twist.

Disclaimer

FOR PROFESSIONAL INVESTORS ONLY. NO OTHER PERSONS SHOULD RELY ON THE INFORMATION CONTAINED HERE.

This material is for information purposes only. Any views expressed are those of the author, and do not necessarily reflect the views of TwentyFour. TwentyFour does not warrant the accuracy or completeness of any information contained herein, and therefore it should not be considered as an indication of trading intent, personal investment advice, or a basis on which to buy, hold or sell any investment vehicle/instrument. As such, TwentyFour accepts no liability for any use, or misuse, of the material in this commentary. This material may not be reproduced, in part or in whole without the express prior written permission of TwentyFour.

Please remember that all investment comes with risk and positive returns are not guaranteed and you may not get back what you invested. Investing in fixed income securities comes with credit risk, default risk, inflation risk and interest rate risk.