The Fed is set to lower interest rates, despite positive surprises (labor, CPI), with attention now turning to the Q2:2019 companies’ earnings season
In his Semiannual Monetary Policy Report to Congress, Chair Powell emphasized two main downside risks for the US economy: i) negative repercussions for business investment due to trade tensions; and ii) persisting concerns regarding global economic growth. Mr. Powell reiterated that the prospect of monetary policy easing has strengthened, especially as long as inflation prospects appear anemic (despite June inflation beating expectations – see Economics Section), while the strong labor market report for June (nonfarm payrolls of 224k vs consensus expectations of 160k) did not alter the Fed’s view.
Recall that the Fed opened the door towards monetary easing at its meeting on June 19th, when circa half of the Federal Open Market Committee (FOMC) members expected interest rate cuts of 50 bps cumulatively by end-2019 in the range of 1.75% - 2%.
Indeed, the FOMC meeting minutes reinforced this view, indicating a variety of incentives for interest rate cuts with: i) several officials stating that a near-term cut was appropriate as an insurance against downside risks; ii) others revising down their estimates for the longer-run normal rate of unemployment (suggesting more room for monetary easing); and iii) some others linking accommodative policy to the softening in inflation and inflation expectations. Overall, our baseline view calls for a 25 bps cut at the meeting on July 31st. The S&P500 crossed the 3000 threshold and long-term nominal Government bond yields increased from depressed levels following Chair Powell’s testimony (see Markets section).
The minutes of the ECB meeting on June 6th were also dovish, with policy makers acknowledging that the ECB staff forecast for inflation in 2021 (1.6%) is “some distance” from target (“below, but close to 2%”) and citing that there is “no room for complacency” regarding the decline in (market-based) inflation expectations (see graph below). The September meeting, which will be accompanied by the updated quarterly ECB staff economic projections, appears suitable for policy action assuming economic growth does not surprise on the upside in the interim.
Recall that the IMF, in its 2019 Article IV Consultation for the euro area, highlighted that it will take several years for inflation to sustainably converge towards target and that monetary policy should remain accommodative until then. The Fund sees limited room for rate cuts (DFR: -0.4%) and appears to prefer asset purchases and credit easing measures, alongside forward guidance, to support the economy. Overall, the Fund foresees real GDP growth of 1.3% in 2019 and 1.6% in 2020 (European Commission: 1.2% in 2019 and 1.4% in 2020).
Chinese GDP growth decelerated in Q2: 2019 by 0.2 pps to 6.2% yoy as expected, albeit the monthly data suggests a pick-up in activity towards the end of Q2. Indeed, activity exceeded expectations in June (retail sales growth: 9.8% yoy vs consensus for 8.5% yoy | industrial production: 6.3% yoy vs consensus for 5.2% yoy), supported by renewed monetary (Total Social Financing was at 10.9% yoy in June – 1 year high), fiscal and administrative policies. Such policies are expected to remain in place over the coming months to support GDP against trade tensions.