On Wednesday 31 July the Federal Reserve may cut interest rates for the first time in over a decade, marking a significant reversal in policy from the tightening cycle that was first pursued by former Fed Chair Janet Yellen. While a rate cut seems like a done deal, markets are still puzzled about the scale of the cut.
As of today, investors forecast a 79% probability of a 25 basis points cut and a 21% likelihood of a larger 50 basis points cut according to CME Fedwatch Tool. Several economic data releases have shown a weakening of the US economy, but there’s still no apparent sign of a recession. While the US economic growth slowed to 2.1% in the second quarter compared to 3.1% in the first quarter, consumer spending remained strong, showing that Americans are not yet concerned about the impact of trade tariffs and slowing global economic growth. However, businesses have been curtailing their investments and if this becomes a trend, consumer confidence will eventually decline, leading to less spending in the future.
Overall, it doesn’t seem like there’s an urgency for a 50-basis point rate cut at this stage. It may even send the wrong signal if the Federal Reserve cuts rates aggressively. A large rate cut may indicate the Fed knows something others don’t, which will likely have negative consequences on asset prices and the US Dollar. Our base case scenario is to see a 25-basis point rate cut on Wednesday with further easing if economic data deteriorates further.
The Fed is not the only central bank aiming to ease monetary policy. This week we’re likely to see a shift from the Bank of England and Bank of Japan towards the same direction.
Trade talks to resume
Trade talks are finally back on the table. US Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer will kick off a new round of negotiations with their Chinese counterparty Vice Premier Liu He on Tuesday. Both parties know they are running out of time to prevent a sharper slowdown in the global economy, however, given the past experiences, investor sentiment isn’t too high. While resolving their core issues seems far from reach at this stage especially when it comes to China’s subsidies and technology transfers, markets need at least a sign of goodwill to prevent a sharp volatile reaction in financial markets.
Earnings and Economic data
The S&P 500 and Nasdaq Composite closed at record highs last week in the wake of better-than-expected earnings from tech giant Alphabet. It seems that equity markets are still running on at a sweet spot pace, and that’s likely to continue if earnings do not disappoint this week. One-third of the S&P 500 companies are due to announce results this week and Apple is likely to attract most of the attention, especially when it comes to iPhone sales.
On the data front, US jobs report will be under the investors' radar, but given that it will be released after the FOMC policy announcement, it will have less of an impact on equities and FX markets. However, data released this week will be a good indicator of future Fed policy.