At the start of 2019, the odds that the Federal Reserve would slice interest rates by 50 basis points, twice the typical change, were virtually nil. Not only were the vast majority of investors betting the central bank would leave rates unaltered after nine hikes, at least 14% believed it might even take them higher.
The complete about-face since — most of which has occurred over the past six weeks — reflects sharp fluctuations in U.S. hiring, slowing economic expansion as the impact of 2017’s tax cuts fade and mounting concerns about the impact of President Trump’s trade wars on the world’s two largest economies as well as Great Britain’s thorny exit from the European Union.
By Monday morning, trading in interest rate futures tracked by CME Group showed a 100% chance the Fed’s monetary policy committee will lower rates at its Wednesday meeting. The only question was how much: The odds of a 50 basis-point cut were 26%, compared with 74% for a reduction of half the size.
The larger reduction appears the most likely to Ellen Zentner, an economist with the New York investment bank Morgan Stanley, who predicts the Fed would then soften hints about further rate cuts.
Chairman Jerome Powell, who has taken the brunt of Trump’s ire over past rate increases that the chief executive believes undercut his efforts to grow the economy, will probably “maintain a dovish tone in his press conference,” afterward, Zentner said.
She expects additional context on the rationale for the rate cut and a discussion of how economic developments will shape the central bank’s outlook going forward.
Dovish remarks, she added, would “keep market expectations leaning toward further rate cuts, as policymakers have emphasized that they wish to maintain the current level of financial conditions.”
The Swiss lender UBS, however, says the Fed may only cut rates 50 basis points by the end of 2020, rather than the 100 basis points traders are expecting in that period.
“The U.S. is at full employment and economic growth is close to trend, but recent communication from senior Fed officials has downplayed strong data,” said Mark Haefele, global chief investment officer for the UBS wealth management business. “The Fed appears to want to deliver an insurance cut to stave off the risk that trade uncertainty weighs on business investment and growth.”
Corporate executives, economists, and even some GOP lawmakers have long warned that higher prices from tariffs the White House imposed on $250 billion of Chinese imports, coupled with a variety of other trade disputes, are likely to curb U.S. growth. Rather than abandon his strategy, however, Trump has argued the Fed should cut rates to buoy the economy while he pursues deals with long-term benefits.
Brexit, the withdrawal from the EU that British voters approved three years ago, presents additional challenges, Powell has said. The country is the world’s fifth-largest economy, and how leaving the EU without a trade deal in place would affect it is unclear.
The nation’s parliament repeatedly rejected a departure agreement negotiated by former Prime Minister Theresa May, and her successor, Boris Johnson, has made the threat of a no-deal Brexit if he doesn’t get a better offer a linchpin in his strategy. His office underscored that point on Monday, dragging the pound lower.
Overall, the currency is worth 17% less today than its $1.47 valuation before the June 23, 2016, Brexit vote that rattled both the existing European order and global markets. Business investment fell through most of 2018, and the housing market has been subdued, the Bank of England said in a February report.
“The new prime minister has indicated he would seek significant concessions from EU negotiators and step up preparations for a no-deal exit,” Haefele said. “But while the prime minister has changed, the political barriers to a no-deal Brexit remain — at least in the short term. The majority of British members of Parliament have expressed, and continue to express, their opposition to leaving the EU without a deal.”
