All paths lead to the Federal Reserve
Market focus is likely to centre on tomorrow’s G20 meeting between US President Trump and his Chinese counterpart Xi Jinping (11:30 local time).
The broader context is the direct, negative impact which the ongoing US-China trade war has had on US and global economic growth and its dovish influence on the monetary policy stance and outlook of major central banks, including the Federal Reserve.
Moreover, in line with our bearish Renminbi view, Chinese policy-makers have used currency depreciation as both a tool to reflate their economy and a weapon to retaliate against the US – as they did, albeit more forcefully, a year ago.
The corollary is that the outcome of this weekend’s meeting (and any subsequent meetings between the two sides) is likely to have a bearing on central banks’ policy decisions in coming months and importantly on the Federal Reserve’s next policy meeting.
Markets are currently pricing 31bp of Federal Reserve cuts on 31st July, broadly in line with analysts’ consensus forecast of a 25bp cut. However, markets are currently pricing in 71bp of rate cuts between now and end-year, which is far more dovish than the 17 FOMC members’ average expectation that 21bp of cuts would be appropriate.
Our approach to discerning how this tension will resolve itself is to compare the current US and global macro backdrop, US policy settings and performance of financial markets with those prevailing prior to the three previous Fed rate-cutting cycles in January 2001, November 2002 and September 2007 (see Figure 3).
The backdrop which the Federal Reserve currently faces most closely resembles the backdrop which prevailed prior to the 50bp rate cut on 6th November 2002, in our view, albeit with some obvious differences which we will explore in future FIRMS reports.
On balance we think that the Fed will be somewhat less dovish than it was nearly 17 years ago by cutting rates 25bp its July 2019 meeting and potentially cutting a second time before year-end – a path for the Fed policy rate which perhaps chimes the most closely with voting FOMC member Bullard’s.
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Olivier is an economist and rates & FX strategist with over 22 years experience in financial markets. He is Director and Founder of 4X Global Research, an independent, London-based consultancy which provides institutional and corporate clients with substantive research, high-quality analysis and insight on emerging and G20 economies and financial markets.