Fed likely to deliver more insurance rate cuts to sustain record-long U.S. expansion amid escalated trade tensions, says Scotiabank

The Federal Reserve is expected to deliver more insurance rate cuts to sustain the record-long expansion in the US economy amid escalated U.S.-China trade tensions, which could weigh on the dollar versus its major rivals at the moment, according to the latest research report from Scotiabank.

A month-long trade truce between the US and China has been over. China vowed on Friday to fight back against US President Donald Trump's abrupt decision to slap 10 percent tariffs on the remaining USD 300bn worth of Chinese products exported to the world’s largest economy.

Given a tight and positive correlation with the EUR, the SGD outperformed most regional peers except the THB on Friday, in response to Trump’s latest tariffs. According to CME FedWatch Tool, Fed Funds Futures are now pricing in two more rate cuts from the Fed during the rest of the year, 25 bp each in September and December.

More Fed monetary easing is needed to reduce both risk-free interest rate and risk premium to boost US stock markets, particularly if taking into account the so-called wealth effect that has a significant implication for US economic expansion.

As the St. Louis Fed chart showed below, there has been a shift in income to capital (ownership of businesses, land and assets) from labor (hourly wages and salaries) in the US. China's central bank said Friday that the country will keep its prudent monetary policy "neither too tight nor too loose" and make adjustments in a timely and moderate manner in the second half of the year, with a variety of monetary policy tools and counter-cyclical adjustments to keep the liquidity at a reasonable and ample level.

The People’s Bank of China (PBoC) is expected to deliver more RRR and/or targeted RRR cuts in the months ahead, supportive of the yuan-denominated government bonds. Meanwhile, EM Asian currencies are likely to suffer from intensified risk aversion further before market sentiment stabilizes, the report added.

"We stay vigilant as it will raise market concerns over further depreciation in the yuan and risk sparking competitive currency devaluation if the PBoC sets USD/CNY fixing above 6.90. When fears over the US-China trade disputes fade away, we would like to sell the dollar on rallies versus regional currencies as major central banks remain on track to re-expand their balance sheets later this year," Scotiabank further commented in the report.