When the Fed cut rates in July 2019 for the first time since 2008, it went to great lengths to emphasize that it was an “insurance cut” - necessary to length the expansion but not the start of a prolonged easing cycle. The challenge for the Fed is that the economic data does not seem to be fitting its narrative. Below are a few concerning developments from the last few weeks:
Global growth looks to be slowing: Global manufacturing PMI fell to 49.3, the lowest level since 2012. Germany registered negative growth in the 2Q19 with concerns that it may already be in a recession.
A resolution on trade remains elusive: Despite delaying the full implementation on all China tariffs, a U.S-China trade deal remains elusive.
- Inverted yield curve: A commonly watched recession indicator - the 2-year vs. 10-year inverted, albeit briefly. The inversion triggered elevated financial market volatility.
Investors are rightly concerned about these issues and have begun to price in further rate cuts from the Fed over the next few months. The below chart shows that the market is pricing in 100bps of expected rate cuts in the next 12 months. It looks likely that without a dramatic improvement in the next few weeks the Fed will likely be forced into further rate cuts before the end of the year. Further Fed rate cuts likely push down bond yields and trigger valuation expansion in equity markets as investors continue to hunt for returns in a low yield world.
Number of Fed rate hikes/cuts priced into the market over the next 12 months
# of 25 bps hikes/cuts
Source: Bloomberg, FactSet, Federal Reserve, J.P. Morgan Asset Management. Market expectations are based on the Fed Funds futures market.