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ECB Hints at Rate Cut, Will Fed Follow Suit? Likely Gainers

Nalak Das

A global economic slowdown looks more inevitable as central banks across the world head for dovish monetary policies. The European Central Bank (ECB) has given a strong signal for more stimulus including a likely rate cut. Central banks of China and Australia are pursuing soft monetary stances. Back in the United States, the Fed has also opted for monetary easing instead of the aggressive stance seen in 2018.

Fed might signal a possible reduction in market interest rate anytime soon during its two-day policy meeting, which started on Jun 18. Fed Chair Jerome Powell is expected to announce the decision at 2 p.m. EST on Jun 19.

ECB Proposes for More Stimulus

On Jun 18, speaking at the ECB Forum in Sintra, Portugal, ECB chairman Mario Draghi gave a strong signal that if economic condition of the Eurozone deteriorates, the ECB will inject more stimulus either in the form of interest rate cut or further asset purchase. “In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required,” Draghi stated.

Per ECB, trade conflict between the United States and China, a possible spat with Eurozone regrading auto tariffs, and geopolitical crisis in the Middle East and other oil exporting countries have taken toll on Eurozone’s export and manufacturing sector. These two are the main growth promoting sectors of the Eurozone economies. Notably, the ECB is maintaining its soft monetary approach since the sovereign debt crisis of 2011.

Fed’s Policy Meeting in Focus

The Federal Reserve started its two-day policy meeting on Jun 18. Notably, on Jun 4, Fed chairman Jerome Powell indicated that a rate cut was likely this year although he refrained from specifying dates. Possibility of a rate cut after the June meeting is very low.

However, market participants will be more interested in Powell’s speech scheduled Wednesday afternoon. His statement is likely to reveal much about the central bank’s future policy stance. Per CME FedWatch, at present, 84.3% responders are expecting the first rate cut in July. Moreover, probability of a second rate cut in September is 65% and a third one in December is 51%.

Fed is possibly facing a dilemma. Reduction of interest rate for three times in 2019 after raising it for four times in 2018 will make Fed’s policy prescriptions highly vulnerable. Such a drastic change in policies may not bode well. Also, with the current benchmark rate of 2.25–-2.5%, Fed has limited ability to reduce interest rate to a large extent.

In case of future economic shock (trade conflict is very much alive), which will spike the unemployment rate, Fed will not be able to raise inflation rate to its target level. Ultimately, it may have to resort to negative interest rate like Eurozone and Japan, which will simply impose tax on bank deposits.

Effect on Stock Markets

In June, Wall Street rebounded after a month-long volatile trading, following indications from Jerome Powell of a possible cut in benchmark interest rate. All three major stock indexes –- the Dow, the S&P 500 and the Nasdaq Composite –- have gained more than 6% so far this month.

Despite little progress on the U.S.-China trade war front, impressive performance of U.S. stocks hinges on a possible rate cut by the Fed. Meanwhile, President Donald desperately wants the central bank to roll back its 1% rate hike in 2018. Trump acquiesced the Fed that had it not opted for rate hike, U.S. GDP would grew 1.5% more in 2018 and the Dow 30 index will be up by another10,000 points.

Likely Gainers

The signal for a possible rate cut by the Fed anytime soon will certainly bolster confidence of market participants on risky assets like equities. A cut in benchmark lending rate will lower borrowing costs for corporations and individuals. Low cost of capital is likely to inject more investment in the economy as well as in the stock market.

Consequently, stocks with strong growth potential, which have performed well even during the market mayhem of May, are likely to gain the most. Shares of eHealth Inc. EHTH, Rent-A-Center Inc. RCII, Strategic Education Inc. STRA, Great Lakes Dredge & Dock Corp. GLDD, ADTRAN Inc. ADTN and Ciena Corp. CIEN are likely to grow further. All these stock sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

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