Chairman of the US Federal Reserve Jay Powell has boosted the market’s expectations that the first interest rate cut in ten years will come this month with a gloomy testimony to a congressional committee.
In a prepared statement Powell said “trade tensions and concerns about global growth have been weighing on economic activity and the outlook” in the US.
Domestically, business investment has slowed notably while manufacturing output continued to decline, Powell said. He said there was “a risk that weak inflation will be even more persistent” than previously thought.
The Fed chair pointed to “a number of government policy issues” that “have yet to be resolved” and could drag on economic sentiment and growth, “including trade development, the federal debt ceiling, and Brexit”.
The glum assessment of the US economy’s prospects cheered the stock markets, who read it as signalling an imminent interest rate cut to try and kickstart the economy.
The S&P 500, the Nasdaq and the Dow Jones industrial average stock market indices all hit record highs shortly after the bell rang at the New York Stock Exchange.
The tech heavy Nasdaq rose 0.9 per cent while the Dow Jones and S&P 500 both rose 0.6 per cent less than an hour after opening.
Both the dollar and short-term government bond yields fell following the release of the statement. The dollar had fallen 0.3 per cent against the euro just before 4pm UK time. Yields on two-year government bonds had dropped by five basis points to 1.85 per cent.
Lower interest rates mean less demand for dollar-denominated financial assets, while bond prices rise as their interest payments look more attractive. Yields move inversely to price.
Insurance rate cuts
An interest rate cut by the Fed would be the first in 10 years. Rates were slashed to record lows in the wake of the financial crisis, but the central bank raised them faster than its peers from 2016.
From the start of 2016 to the end of 2018 the Fed raised its target federal funds rate from 0.5 per cent to between 2.25 and 2.5 per cent.
Today, Powell said that in June many members of the rate-setting committee “saw that the case for a somewhat more accommodative monetary policy had strengthened”.
“Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US economic outlook,” he said.
US President Donald Trump has vociferously criticised the Fed for raising rates too quickly, saying it has held back economic growth. Many economists share this view, although not Trump’s assessment that the central bank “doesn’t know what it’s doing”.
Powell’s dovish tone today was “slightly surprising given benign trade developments following last month’s G20 meeting and the recent rebound in nonfarm payroll employment,” said Michael Swell, co-head of global portfolio management at Goldman Sachs Asset Management’s fixed income team.
“His comments around slowing growth against a backdrop of muted inflation and elevated uncertainties is consistent with “insurance rate cuts” this year which we think amounts to easing at one or two meetings,” he said.
Aberdeen Standard Investments senior global economist James McCann said: “A rate cut in July is now all but certain. The strength of last week’s jobs number did lead some to think that the Fed may pause for thought. It’s clear from this that they won’t.”
“There’s an element here of the Fed wanting to take pre-emptive action,” he said. “From a growth perspective, there’s nothing in the data that suggests a rate cut is strictly necessary.”
“It’s more of a case of them being worried about what might happen to growth in the future.”
Richard Flynn, managing director at Charles Schwab, said: “If the economy holds up and the rate cuts are simply “insurance,” stock markets could rally strongly. However, if the economy weakens, the market’s rate-cut optimism could turn negative.”
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