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Are investors placing too much hope in the Fed? As US-China trade war lingers, analysts see fewer rate cuts than markets

Chad Bray, Joy Pamnani chadwick.bray@scmp.com

As uncertainties over the US-China trade war continue to weigh on sentiment, investors are increasingly looking to the US Federal Reserve to cut rates and provide a boost to what has been an extended economic cycle.

Investment strategists and economists, however, said financial markets may be a bit too optimistic about where the central bank is headed " and that could be bad for emerging markets.

The financial markets are expecting as many as three interest rate cuts " or about 75 basis points " this year. Most observers, however, said they expected cuts of 25 to 50 basis points, unless the trade war escalates further.

"Given that the market is pricing in roughly three rate cuts by the end of the year, anything less would disappoint expectations and cause headwinds for Asian credit and currencies," Mark Haefele, UBS's chief investment officer for global wealth management, and Min Lan Tan, the head of the Swiss bank's Asia-Pacific chief investment office for global wealth management, said in a recent report.

The Fed is expected to announce its decision on interest rates on July 31, but investors could get a preview when Fed chairman Jerome Powell testifies over the next two days before the House Financial Services Committee and the Senate Banking Committee in Washington.

BlackRock sees weak 2nd-half China growth despite stimulus amid trade war

Hiring rebounded strongly in June in the US, easing fears the American economy was weakening, and could take pressure off the Fed to act immediately.

But that has not stopped US President Donald Trump from sharply criticising the central bank, as he continues to press the Fed to cut rates. "If we had a Fed that would lower interest rates, we'd be like a rocket ship," Trump said last week.

Larry Kudlow, director of the White House's National Economic Council, said at a CNBC event on Tuesday the Fed's last interest rate increase in December was "unnecessary".

" Donald J. Trump (@realDonaldTrump) June 24, 2019

Frances Donald, Manulife Investment Management's chief economist and head of macroeconomic strategy, said on Tuesday two rate cuts were likely this year "as insurance against deteriorating growth in the face of heightened uncertainty, but also to stroke inflationary pressures, which have been absent". If the trade war escalates, further rate cuts could be in the mix, Donald said.

The big question for the Fed is whether the trade war reignites after the United States and China reached a ceasefire following discussions between Trump and Chinese president Xi Jinping at the G20 Summit last month.

Nomura said on Tuesday the US was likely to put tariffs on nearly all goods imported from China by the end of this year, which could cause China to ramp up its own stimulus.

With trade war likely to deepen, worst is yet to come for China's economy, says Nomura

The US already has 25 per cent tariffs on about US$250 billion of Chinese-made products, but held off adding tariffs on another US$300 billion of goods, many that would directly led to American consumers paying higher prices.

On Wednesday, S&P Global Ratings cut its economic growth forecast for Asia-Pacific to 5.1 per cent for this year and 2020, saying growth in capital expenditure had softened in the region because of the trade war and is negative impact on more trade dependent economies.

"We still believe that achieving a comprehensive deal that would remove uncertainty from the bilateral economic relationship is challenging," said Shaun Roache, S&P's Asia-Pacific chief economist. "Thorny issues remain on market access, intellectual property protection, an agreement monitoring mechanism and potentially restructuring China's state-owned entities. One side may need to make substantial concessions to arrive at a lasting deal, and while this is possible, it seems unlikely, at least over the next 12 months."

Will Leung, head of investment strategy for Standard Chartered's wealth management business in Hong Kong, however, said the "majority of the negative" associated with the trade war had already been priced into the market.

"Geopolitics is clearly an area of concern. While risks are impossible to quantify and difficult to factor into decision-making, they argue for a less aggressive investment stance than would otherwise be the case," Standard Chartered's global investment committee said in its latest outlook. "In our view, trade tensions are a symptom of the shift from a US-centric world order to a more multipolar one amid rising Chinese economic, military and political power. To what degree the US accepts China's increased role in global affairs will be key to the evolution of US-China tensions in the coming years."

Standard Chartered said one to two rate cuts by the Fed were likely to extend the economic cycle, helping to ensure a slowdown in economic growth that is a "temporary soft-spot rather than the early stages of a recession".

Aninda Mitra, senior sovereign analyst at BNY Mellon Investment Management, said he expected the Fed to "take out some insurance" with a rate cut of as much as 50 basis points this summer.

"Our view is also the US economy is not slumping. Labour markets are still tight," he said. "We think one-off or two rate cuts back to back would be sufficient to lend some support as global uncertainty takes its toll on trade volumes."

Athanasios Vamvakidlis, a Bank of America Merrill Lynch forex strategist, said uncertainty over trade was affecting the weak global economic outlook and "risks for an even sharper slowdown will increase fast" if the uncertainty persists.

"The Fed has positioned itself between a rock and a hard place," Vamvakidlis said. "The [non-farm payrolls] data was strong. Other data has been mixed or even weak, but the overall picture does not justify the aggressive monetary policy easing that markets are pricing, unless in a trade war scenario, and particularly when we take into account the limited policy ammunition, which the Fed may not want to waste. We see a risk that the Fed may disappoint markets no matter what they do."

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2019 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2019. South China Morning Post Publishers Ltd. All rights reserved.