US: A Test Of ‘Patience’

'Cross-currents' have led the Federal Reserve to adopt a more 'patient', data dependent approach to monetary policy for 2019. While the market is pricing in an eventual cut as the next Fed move, we continue to look for one last 25 basis point hike in the summer.

The next move on rates

With the government shutdown over, we are receiving the backlog of data from the end of 2018. Most notably, 4Q GDP slowed by less than feared to 2.6% annualised, which left full year 2018 growth at 2.9%. The aggressive tax cuts at the beginning of 2018 put the US economy on a strong footing, with momentum being well maintained despite escalating trade tensions and the financial market turmoil seen in the latter part of the year.

It was for these reasons that the Federal Reserve adopted a more cautious position in January. Earlier this week, Fed Chair Jerome Powell repeated comments that economic and financial market 'crosscurrents and conflicting signals' have created uncertainty. While officials continue to believe the US economy is broadly in good shape, the fact that inflation pressures are perceived to be 'muted' means the Fed can afford to be 'patient' with regards to decisions on future policy changes.

At present, markets believe that the Fed’s neutral stance will eventually give way to policy easing with Fed funds futures contracts pricing in a 25 basis point rate cut by the summer of 2021. However, we continue to believe that the next move is more likely to be an interest rate increase.

Indeed, the economic tensions appear to have eased since the start of the year. The US-China trade truce that was called in early December delayed the imposition of additional tariffs on imports from China. President Trump continues to seek a concrete deal that will result in a lower bi-lateral deficit together with Chinese concessions on intellectual property and technology transfer. 

The hope is that a late-March summit can seal the deal with a 150-page document reportedly being finalised. Meanwhile, risk appetite has returned with equity markets recovering all of the losses seen since the beginning of October. Interestingly, gasoline prices have not rebounded to anywhere near the same extent, so household spending power continues to benefit.

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