Anxiety over Fed’s signalling of rate cut


THE Federal Reserve’s signalling of a possible interest rate cut may not be taken as a positive sign, rather it could be an indication of things worse to come.Those wishing for rate cuts to boost markets, should be careful of what they wish for!

There could be some downplaying of a rate cut with “non-existent” inflation and vague hopes of further rebound and stretching of the US economic expansion.

The reality is, a rate cut is usually a signal of an approaching market top. During the period approaching the last US recession, the New York Composite Index rallied for about a month before the first rate cut following a rate hike cycle.

It continued to rally for almost another month before commencing on its first round of steep falls, going into the 2008 recession.

US recessions have commenced between one and seven months or an average of three months, after the first rate cut on the end of a rate hike cycle.

While the Fed aims to sustain the expansion, and possibly make “insurance cuts,” ammunition to fight a recession this time is running thin.

In the past, when recessions hit, the Fed lowered rates by 500 basis points or 5%, its current target range of 2.25% to 2.5% is just about half of that!

Economic expansion

In this month, the US economic expansion that started in July 2009, is exactly 10 years, matching those of the Bill Clinton years of growth from March 1991 to March 2001.

A “mild” US recession next year is predicted by Zurich Insurance, warning that global and US economic conditions will likely worsen.

There are fears that a US rate cut by July may not save the situation as trade war uncertainties and disruptions bite into the natural business cycle, besides the lagged effects of any rate cuts.

Amidst expectations for multiple rate cuts these two years, the Fed is forecasting one cut next year.

The US manufacturing purchasing managers index (PMI) from IHS Markit fell to a borderline 50.1 in early June, the lowest since September 2009.

The PMI for the US services sector, which also came in below expectations, dropped to 50.7, the lowest since February 2016.

A Fed gauge of factories in NY, the NY Empire State Manufacturing Survey’s main index plunged in June by 26.4 points to minus 8.6, the lowest since October 2016.

The Philadelphia Fed’s manufacturing index dropped to 0.3 in June from 16.6 in May, the lowest since February when it hit zero.

New orders and employment also fell under both gauges. US jobless claims are closely watched; they fell more than expected in the week ended June 15 after three straight weekly increases in claims.

There were concerns that the US labour market was losing steam following a sharp slowdown in job growth in May.

Even as the debate rages on the effectiveness of rate cuts, there are concerns over countries using quantitative easing (QE) or large scale bond purchases that increase money supply.

QE is not helping much in Europe and Japan, which also have limited room to cut rates.

The worry is cheap funds from rate cuts and QE may just be poured into financial assets, and not into the real economy.

Government or fiscal spending that also increase money supply, can come to the rescue but that has its limits especially with countries facing twin budget and current account deficits, or fiscal deficits.

“Now, it is a waiting game. The pain trade (of a widely followed asset class taking an unexpected turn) is coming and everyone is girding for the hit,’’ said Pong Teng Siew, head of research, Inter-Pacific Securities.

Not much hope is pinned on a US-China trade resolution when the two top leaders meet at the G20 summit in Japan in the coming week.

While there could be another round of ceasefire, and resumption of talks, everyone is watching for any full-blown wars involving not just trade or the US and China only.

The damage could be widespread from the “manufacturing of uncertainty.”

Emerging markets (EMs) which could have a reason to cheer on a potentially weaker dollar following rate cuts, may face other challenges.

There may be some relief from the inflationary impact of a strong dollar, but EMs with high risks such as twin or high fiscal deficits, will likely come under pressure when global risks and hence, the appetite for safe haven assets, pick up.

“The challenge is whether it will be an isolated risk or lead to a contagion crisis,’’ said Anthony Dass, head of AmBank Research.

  • Columnist Yap Leng Kuen notes the message that an attitude of ‘winning at all costs’ may not serve well in negotiations. The views expressed here are entirely the writer’s own.
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