FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

  • Financial markets plunged after mixed messaging by the Federal Reserve, and later a 10% tariff on all remaining imported Chinese goods was announced to take effect in September.
  • The Federal Reserve cut its policy rate by 25 basis points this week, but markets were unhappy with the lack of commitment to cut more if necessary.
  • Slowing global economic growth and past tariff actions suggest that another cut is likely in September. However, escalating trade tensions may require even lower interest rates to help cushion the fallout.


 The Fed is Not Done Cutting Rates

Financial News- US Business Investment Growth Strongly Tied to Global Growth Events this week caused a lot more turmoil than usual for financial markets in mid-summer. Global financial markets reacted quickly and negatively to mixed messaging by Federal Reserve Chair Jerome Powell. The very next day, a tweet by U.S. President Trump called for a 10 % tariff on the remaining $300bn in untariffed Chinese imported goods beginning September 1st. Any goodwill from the Federal Reserve was quickly thrown into reverse. Global equity and commodity markets sold off with investors seeking the safety of government bonds. The tweet came after talks broke down during a brief meeting between trade representatives from the U.S. and China.

Tackling these two events separately, financial markets wanted more clarity on the Fed’s commitment to further rate cuts. First off, many were puzzled as to why rates were cut at all given the solid performance of the U.S. economy. The data this week confirmed that global developments had yet to take a significant toll on domestic economic activity. July payrolls came in as expected, with 164k jobs created, and wage growth firmed up slightly to 3.2% y/y. What’s more, consumer spending for June expanded at a healthy pace, and core inflation registered a slight improvement. Lastly, although motor vehicle sales slowed to a 16.9 million annual pace in July, this remains in line with expectations for 2019 as a whole.

The reason why the Fed is cutting is simple. The data reflects past performance, and forward-looking surveys offer a slightly less favorable outlook. For example, July’s ISM manufacturing survey again edged down and is close to tipping into contraction. Moreover, growth in world GDP is strongly correlated with domestic business investment with a short lag (Chart 1). As a result, the half-point decline in global growth since last year has weighed on business investment enough to shave about a tenth of a point off U.S. growth.

Financial News- Threatened Tariffs to Take Another Bite out of U.S. and Global Economic GrowthThis week’s 25 basis-point cut should help to offset the impact of a slowing global economy on domestic growth, but it’s likely not enough to insure against the fallout from past tariff actions. A follow-up rate cut in September should help alleviate some of the pain. However, recent steps by the U.S. administration to place tariffs on the remaining Chinese imported products is likely to now take a deeper bite out of economic activity (Chart 2). This last tranche of goods tilts more heavily towards consumer products and could eventually result in higher consumer prices than previous tariff actions. Furthermore, China is likely to retaliate by taking further actions to impede U.S. business activity in the country. It may also choose to let its exchange rate depreciate beyond US $7, an important psychological threshold that could send tremors through global financial markets.

With no end in sight for trade tensions, any larger-than-anticipated negative impact on consumer spending, confidence and business investment would likely call for even lower interest rates to help support U.S. economic growth.

Fotios Raptis, Senior Economist | 416-982-2556

 


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