In the face of slowing global economic growth, continued trade tensions and the prospect of a “hard Brexit”, the FOMC seems set to announce a reduction in interest rates at its next meeting. We expect a 50-basis-point cut that will start a new rate-cut cycle, and we think the markets should react favourably.
The FOMC meeting on 30-31 July seems likely to mark a major turning point in monetary policy for the Fed
The Fed appears set to enter a rate-cut cycle; we expect the FOMC to announce a decrease of 50 basis points
Given a weakening global economy and persistent trade tensions, the Fed likely wishes to act pre-emptively as an exercise in risk management
Markets might be surprised at the news, but will likely react positively given the historically favourable impact of rate cuts on equity markets
It now seems likely that the US Federal Reserve will initiate a rate-cut cycle at the 30-31 July meeting of the Federal Open Market Committee. Paving the way for this decision were a range of recent announcements from FOMC members – including statements by Fed Chair Jerome Powell, Fed Vice Chair Richard Clarida and New York Fed President John Williams – as well as the minutes of the last FOMC meeting.
US economic data such as job creation, retail sales, production and inflation rose surprisingly in June, and they show an economy that is still robust. However, the Fed no longer seems to base its policy-making on data. It appears to be focusing instead on slowing global economic growth, which leads to diminishing demand, and on the high-risk environment stemming from trade tensions and the prospect of a “hard Brexit”.
The Fed’s likely decision to lower rates would therefore appear to be based on its approach to risk management: if doing less appears riskier than doing more, then the Fed feels justified to do more now than would otherwise seem necessary.
Market expectations of a 50-basis-point rate cut as early as July have been quite volatile, recently dropping from 40% to a lower level, according to fed funds futures. However, we believe that the Fed’s risk-management policy justifies a 50-bp reduction. There are two arguments for this:
Today’s interest-rate level, which is near the “zero lower bound”, encourages the Fed to take voluntary action to maximise its effectiveness.
Given the delay in transmitting a rate cut to the real economy – transmission takes between six and 12 months – the Fed may feel it has no time to lose and could want an insurance policy.
It should also be noted that the Fed is experiencing pressure from two fronts. President Donald Trump and the markets want a rate cut, and the Fed is also feeling pressure to address the US dollar – which some economists estimate is overvalued by around 10%. Despite what central bankers say, maintaining a desired exchange rate seems to have become an unacknowledged objective.
If the Fed decides to cut rates, the markets might be surprised but should react favourably. We think a 50-bp cut will lead to a “bull-steepening” phenomenon, a compression of spreads, a lower dollar and the continuation of a dynamic that is beneficial for the equity markets.
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Panama, Peru, and Uruguay.
This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Distributors LLC, distributor registered with FINRA, is affiliated with Allianz Global Investors U.S. LLC; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG, licensed by FINMA (www.finma.ch) for distribution and by OAKBV (Oberaufsichtskommission berufliche Vorsorge) for asset management related to occupational pensions in Switzerland; Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan];and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.