It’s been an eventful six weeks for the global economy, complicating the Federal Reserve’s efforts to steer the U.S. economy through a dark global outlook facing increasing uncertainty.
Since the Fed’s July 31 decision to cut rates for the first time in over a decade, the U.S. designated China a currency manipulator, the yield curve inverted for the first time in over 10 years, China and the U.S. ratcheted up their tariffs, and oil prices spiked as geopolitical tensions on the Arabian peninsula flared up.
All eyes are on the Fed’s announcement Wednesday, where Fed Chairman Jay Powell will not only announce its move on rates but release a new round of “dot plots” projecting policymakers’ expectations for where rates could be in the future.
As of Tuesday morning, Fed funds futures contracts were pricing in a 65.8% chance of a 25 basis point cut in its Wednesday announcement, with the other 34.2% of bets on no rate change.
On Wall Street, the expectation for a cut appears stronger, with JPMorgan, Goldman Sachs, Bank of America Merrill Lynch, TD Securities, Rabobank, UBS, Wells Fargo, and Morgan Stanley all predicting a 25 basis point decrease.
“The case for a cut has increased since the July meeting as the data flow in the U.S. has softened and uncertainty remains in the outlook,” Bank of America Merrill Lynch wrote September 13.
Clouding things further: continued criticism from President Donald Trump, who recently pushed Jay Powell to lower rates to “the lowest.”
Global concerns
The prevailing question for Wednesday is whether the Fed sees increased risks to the U.S. economy from the wave of headlines over the last six weeks.
The biggest headline: an announcement from China on Aug. 23 that it would slap tariffs on another $75 billion of U.S. goods, pushing Trump to increase tariff rates on Chinese imports as high as 30%.
Shortly before announcing his retaliatory tariffs, Trump expressed frustration that the Fed was not acting more aggressively on rate cuts and described Powell, who was his own pick for Fed chair, as a threat on equal footing with Chinese President Xi Jinping.
....My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?
— Donald J. Trump (@realDonaldTrump) August 23, 2019
The higher tariffs appear to present only increased trade risk to the U.S. economy, a risk that Powell acknowledged in July as a key reason for needing an “insurance” cut of 25 basis points.
New York Fed President John Williams acknowledged in early September that Chinese trade concerns have led to “angst” among U.S. businesses pulling back on investment. Weaker manufacturing numbers have also shown tangible impacts on the U.S. economy as a result of the trade war.
“On our own shores, concerns around trade policy with China are adding to an uncertain picture,” Williams said September 4.
The geopolitical picture globally has darkened, as well. The European Central Bank moved last week to counter continued weakness in the Eurozone with more stimulus. In China, weaker industrial production has extended worries of a slowdown.
Complicating things further were developments on the Arabian peninsula this weekend, where a drone attack on a Saudi Arabian crude-processing center triggered a sharp spike in oil prices.
Deutsche Bank’s Matthew Luzzetti said a spike in oil prices should “reinforce the Fed’s already dovish bias.” Luzzetti wrote Sept. 16 that higher energy prices should not dramatically change the Fed’s concerns over the persistent undershooting of its 2% inflation target, since its preferred measure of prices (core personal consumption expenditures) is an inflation reading that strips out oil prices.
“Barring a more substantial geopolitical flare-up that leads to a sharp tightening of financial conditions, this move in oil should have only modest effects on the US economy,” Luzzetti wrote.
How robust is the US?
As a result of increased global weakness and trade tensions, many expect Powell to repeat his talking points on July’s “insurance” cut in justifing another 25 basis point cut Wednesday.
But why not 50 basis points?
The Federal Open Market Committee already has a rift between policymakers favoring accommodation and the two voters that do not (Boston Fed President Eric Rosengren and Kansas City Fed President Esther George).
At the core of this ideological divide is the robustness of the U.S. economy in dealing with the risks associated with global growth and trade.
Domestically, data since the last meeting have reflected only modest changes in the health of the U.S. economy. The most recent employment report showed tepid growth of an estimate-missing 130,000 jobs in August. But personal consumption, which Powell has described as the main driver of the U.S. economy, appears to be chugging along with figures in the second quarter increasing at an annualized rate of 4.7%, the best reading since 2014.
In remarks in Switzerland on Sept. 6, Powell painted a more optimistic outlook on the U.S. economy, repeating his commitment to “act as appropriate to sustain the expansion” and saying that he “does not see a recession as the most likely outcome for the United States or the global economy.”
Capital Economics wrote Sept. 11 that despite the heavy news flow, the underlying fundamentals do not point to an aggressive rate cut coming on Wednesday.
“The data haven’t yet deteriorated nearly enough to justify a larger 50bp move, although we do expect a further gradual slowdown in economic growth over the coming months to prompt one final 25bp cut in December,” Capital Economics’s Andrew Hunter wrote.
But never rule anything out.
Reflecting the breadth of differing opinions on the FOMC, St. Louis Fed President and voting member James Bullard has publicly stated his support for a 50 basis point cut to address the “global shock” of tariffs.
The Fed’s policy decision will be announced at 2 p.m. ET on Wednesday and will come with a new round of economic projections. Powell’s press conference will begin at 2:30 p.m. ET.
Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.
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