Employment growth cooled noticeably in May, supporting our view that the Fed will cut rates in 2019, lowering the funds rate by 25 basis points at both the September and October Federal Open Market Committee (FOMC) meetings. Moreover, we do not rule out the possibility that the Fed could ease sooner (and further) if downside risks to the economic outlook continue to increase.
The building case for rate cuts
Inflation remains below the Fed’s 2% target. While the Fed has characterized the recent deceleration as “transitory”, we expect the core personal consumption expenditure (PCE) inflation rate to finish the year at 1.6%, exactly where it stands today.
Meanwhile, the recent escalation in the trade war has called our previously upbeat outlook for the US economy into question. We believe ongoing uncertainty surrounding recent (and future) tariff developments will lead firms to adopt a wait and see attitude.
Business investment has begun to soften. If companies also pullback on hiring, then a weaker job market will eventually undermine consumer spending. We now look for real gross domestic product (GDP) growth to remain at or below trend over the coming six to eight quarters.
If the trade situation with China were to be (unexpectedly and quickly) resolved, we still believe lingering uncertainty over a renewed flair up would keep firms cautious. Thus, even under a “best case” scenario, we do not expect the US economy to regain upward momentum over the second half of the year. As growth cools and inflation remains below mandate, the case for the FOMC to undertake “insurance” cuts – a la the late 1990s – will mount.
A weaker-than-expected payroll gain in May strengthens the argument for a rate cut but does not necessarily suggest urgency for the Fed to act. Our forecast calls for 25 basis points cuts in both September and October. At next week’s FOMC meeting, we believe the Fed will indicate its willingness to act. The data and/or developments on the trade front will then determine the timing of the first rate cut. If conditions deteriorate or downside risks rise, the Fed could take action in July.