HIGHLIGHTS OF THE WEEK
- In the main financial event of the week, the Federal Reserve cut its key lending rate by 25 basis points, but was mum on the prospect for additional cuts. Our latest forecast sees slower economic growth leading to at least one more rate cut.
- Fed rate cuts will help to offset some of the dampening effects of trade-uncertainty and weak global growth. In fact, this week saw early signs that the American housing market is responding to lower rates.
- Oil prices spiked early in the week on the attack in Saudi Arabia but gave up much of the gains as the week ended. Elsewhere, the strike at GM is likely to add volatility to the economic growth profile.
Fed Cuts Rates, More to Come
The main event for investors this week was the Fed’s rate decision. Equity markets managed to hang on to last week’s optimism. However, long-term Treasury yields were a little lower as bond markets remain cautious on the economic outlook.
As expected, the Fed cut its key lending rate, but there was little change in its economic forecasts. Investors may have been disappointed by the Fed’s “dot” plot, which showed the median FOMC member does not expect to lower rates in the next few years. It is important to note that Chair Powell de-emphasized the “dots” in the press conference after the decision. He argued that when the Fed is dealing with a high degree of uncertainty and heightened data dependency the dots farther out have less meaning.
Recent history has borne this out. As recently as June of this year, the median FOMC member did not expect to cut rates in 2019 (Chart 1). In the three months since, the Fed has cut rates twice. The FOMC will clearly shift in response to risks to the economic outlook. It is late in the business cycle, with limited pent-up demand and mounting geopolitical risks. This requires the dot plot to be taken with several grains of salt.
Our new forecast discusses how a lower growth trajectory over the next year and continued uncertainty on the trade front is likely to lead the Fed to cut rates once more this year. Indeed, the Fed is not the only central bank easing policy. Easier financial conditions globally should help soften the negative cycle taking hold in sentiment, and ultimately sow the seeds for a modest firming in global economic growth in 2020.
Here in the U.S. we are finally starting to see the positive impact of falling interest rates. The one percentage point drop in mortgage rates since late 2018 is finally providing a boost to the housing market (Chart 2). Residential investment is likely to expand in the third quarter for the first time in almost two years. We expect it to continue to grow at a modest pace, as positive demand forces – record-low unemployment and low mortgage rates – push up against challenges on the supply side – a lack of inventory of homes for sale, and still-inadequate construction.
Adding to an eventful week, the GM strike halted production at more than 30 U.S. plants. There are few signs of a deal, and the strike is likely to subtract around 0.1 percentage points off real GDP growth in Q3. The impact on fourth quarter growth will depend on how long it lasts and on how quickly GM ramps up activity after the strike. A four-week strike would see a very limited bounce back in activity in the fourth quarter, but would push the rebound in growth more into the first quarter of 2020.
Finally, oil prices have fallen back after their spike on Monday. While the increase was startling, oil prices remain about 18% below their year-ago level, and prices at the pump continue to put downward pressure on inflation, adding to consumer purchasing power – at least for now.
Leslie Preston, Senior Economist | 416-982-7053
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