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The Federal Reserve is expected to deliver a 25bp cut at each of the next five meetings; the target range would also be most likely lowered to 0.75-1.00 percent at the March meeting, according to the latest research report from Danske Bank.
At the July meeting, the Fed gave three reasons for cutting: (1) higher (trade) uncertainty, (2) slower global growth and (3) inflation remaining below 2 percent. Since the meeting, an escalation of the US-China trade war has been seen (although the next round of tariffs has been delayed by a couple of months) and risk sentiment become shakier.
One important indicator for the Fed is the US 2s10s spread, which reversed this week. Economic indicators outside the US have been weak, with weaker-than-expected Chinese data for fixed asset investments, industrial production and retail sales, German GDP contraction in Q2 and a very downbeat ZEW survey.
While actual US CPI inflation has surprised to the upside in recent months, market-based inflation expectations are low (1.6 percent versus 1.7 percent when the Fed started its U-turn) and it is difficult to see any reasons why inflation should accelerate out of control any time soon. US retail sales were strong, however, the report added.
A large cut of 50bp or more still seems overly stretched to us. Historically, larger cuts (and cuts between meetings) have happened when the US is already in recession with increasing unemployment. Initial jobless claims have, for example, risen prior to all larger cuts since 1990.
The Fed is recognising that the macro outlook has become more uncertain but still sees its easing cycle as a "mid-cycle adjustment" and not recession cuts.
"Our new Fed call is slightly more aggressive than currently priced in by markets but, in our view, current pricing seems fair when the Fed is not going to pre-commit to cuts. That said, if the Fed really wants to reflate the economy and markets (i.e. increase inflation expectations, get a strong relief rally in equities and an immediate steeper US curve), it may need to commit more to easing and/or cut more and faster," Danske Bank further commented in the report.
