U.S. Outlook: Expect Another Fed Rate Cut

Scott Anderson
Chief Economist

U.S. Outlook: Expect Another Fed Rate Cut At The End Of The Month

The need for another quarter-point Federal Reserve interest rate cut at the end of October continues to increase.

In fact, more cuts will likely be needed in the months ahead to stem the tide of slower U.S. and global economic growth.

As September U.S. economic data continue to trickle in, it is clear the U.S.-China trade war escalation in August and September did measureable damage to U.S. economic growth.

The unexpected decline in U.S. retail sales and bigger-than-expected decline in industrial production in September are only part of the story.

Talking heads on the financial news channels keep repeating the mantra that U.S. consumer spending is robust. However, the truth is real consumer spending growth peaked way back in August 2018, at 3.7% year-on-year, and has since slowed to a 2.3% year-on-year growth rate. Still okay, but nothing to brag about. Further slowing in consumer spending is forecast as real income and job growth deteriorate further into 2020.

Industrial production growth has also steadily slowed on a year-on-year basis since hitting a peak of 5.4% growth in September 2018. It turned negative for the first time last month.

The bottom-line is that it’s not just the September GM strike that is sinking U.S. manufacturing prospects. U.S. manufacturing woes are part of a larger story of global deterioration and trade protectionism that is becoming more visible by the day. The Fed needs to respond to the multi-month slowdown by further easing monetary policy.

We also saw falling ISM purchasing manager indexes, reflecting a contraction in the U.S. manufacturing industry. The slowdown is starting to infect the U.S. service sector, too. The ISM Manufacturing and Non-Manufacturing surveys both fell sharply last month, dropping to levels not seen since 2009 and 2012, respectively.

Hawks on the FOMC may try to brush off this economic indicator weakness as just a one-month blip in an otherwise favorable economic environment. What is harder to explain away and more troubling, in my opinion, is the sharp retreat in both survey-based and market-based inflation-expectation measures last month.

Core inflation is already running well below the Fed’s 2.0% medium-term inflation target. The fact that inflation expectations are moving further away from the Fed’s mandated goals suggests the central bank may still be behind the curve. This possibility bolsters the case of the doves that more accommodation will be needed to guard the Fed’s inflation mandate.

After the next interest rate cut, I think the FOMC will pause to monitor the impact of 75 basis points of cuts on the economy and inflation. Some FOMC members will surely be concerned that the monetary easing we have seen from the Fed and global central banks have done little to change the economic outlook, and instead have helped re-inflate asset prices that may already be in bubble territory.

Indeed, financial instability is one of my top three economic risks that keep me up at night. The other two are the U.S.-China trade war and a no-deal Brexit. We have had some encouraging headlines on the latter two risks over the past week. But the financial instability risk still looms large and could become more severe as the Fed continues to ease monetary policy.

After a decade of ultra-loose monetary policy, the side effects of monetary policy medicine are becoming almost as dangerous as the disease. Still, inaction at this point is not really a viable option either, as recession would be likely in 2020 without more monetary support.

For more, click here to download my full U.S. Outlook, delivered on October 18.

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