Year of the Rat outlook: Will the Fed keep rates steady?

Every Chinese New Year, AsianInvestor makes 10 predictions about developments that will affect global financial markets and the portfolios of Asian investors, especially asset owners. These developments can focus on asset classes, geopolitical events, or structural issues surrounding particular markets.

In this Year of the Rat outlook, we consider the likelihood that the US Federal Reserve will reduce interest rates further, following a set of cuts in 2019.

Will the US Federal Reserve cut interest rates?

Answer: No (unless the US economy worsens)

The course for 2020 was set on January 29, at The Federal Reserve’s (the Fed) first policy meeting of the year. The central bank’s unanimous decision was to maintain the key overnight lending rate in a range of between 1.5% and 1.75%.

“We believe the current stance of monetary policy is appropriate to support sustained economic growth, a strong labour market and inflation returning to our symmetric 2% objective,” Jerome Powell, the Fed chairman, said at the following news conference.

He noted signs that global economic growth was stabilising and diminishing uncertainties around trade policy, concern about both of which were key factors in the Fed’s decisions to cut rates three times last year.

The Fed’s latest policy meeting proceeded in line with expectations, sources tell AsianInvestor. Its comments and chair Powell’s press conference also reinforced the view that the Fed is likely to stay put for the rest of 2020.

The agency’s tone on consumer spending has become a bit more dovish, describing it as looking moderate instead of strong. But Powell also noted the limited room to deal with the next downturn. This implies that the threshold for any rate policy change, either tightening or loosening, would be high. Treasury yields fell on the back of Fed’s stance, as well as the relatively short-term uncertainties from the coronavirus outbreak.

With global central banks still focusing on downside risk to growth, instead of upside risk to inflation, the search for income continues. Some sources expect Asian investors to remain focused on the downside risk from the coronavirus outbreak for now, as the number of confirmed cases continue to rise, albeit mostly in China.

In the longer term, the likelihood of a 2020 interest cut from the Fed gets a bit more blurry. The big factor will be whether the US economy can maintain its momentum.

If the US economy does materially slow, it's likely that US president Donald Trump would launch another pressure campaign for the Fed to cut rates

If its economy does materially slow, it's likely that US president Donald Trump would launch another pressure campaign for the Fed to cut rates, particularly ahead of the next presidential election in November. And while Powell has taken measures to underscore that the Fed's policy decisions are separate from the US president’s agenda, a further cut of 25 basis points might turn out to be make sense in the event there is a noticeable slowdown.

This is certainly possible. The US may have forged part of a trade agreement with China, but the structural reasons behind it (and most of the tariffs) still exist. Furthermore, top consumer spending is likely to moderate further, which could require further stimulus measures. In that scenario a rate cut would be sensible.

But such a cut is not at this point a likelihood. While there are considerable headline risks to global GDP growth, the US economy is considered to be operating at a good and generally stable place, sources said following the Fed meeting on January 29. The world’s largest economy is has very low unemployment and is creating more jobs, albeit with some modest slowing in the pace of job growth.

Overall expectations are that the Fed will only cut rates once in late 2020, if necessary, and a hawkish policy approach appears unlikely given short-term risks such as the coronavirus, the further progress of the fragile US-China trade agreement and the upcoming US presidential election. Those risks might also prompt investors to consider diversification and focus on long term asset returns, to help navigate such uncertain times.

It also makes sense to pay particular attention to comments by senior Fed officials; any mention of concerns about “financial conditions” could prove to be a portent for a rate cut and looser stimulus plans. 

Previous Year of the Rat outlook articles: 

Will US president Donald Trump be re-elected? 

Will US private equity reach bubble valuations?