Fed launches ‘pre-emptive rate strike’

The US Federal Reserve (the Fed) has cut its funds rate by 25 basis points to 2-2.25 per cent, marking the first reduction since the peak of the global financial crisis in December 2008.

According to ING Economics’ chief international economist, James Knightley, the Fed’s rate cut was a “precautionary, pre-emptive policy change” to “ensure that the US economic expansion continues for a good while longer”.

AMP Capital chief economist Shane Oliver agreed, adding that continued uncertainties surrounding the trade war between the United States and China and tensions between the US and Iran have posed a threat to global economic stability.  

“With underlying US growth still solid and the jobs market tight, this should be seen as the Fed taking out some insurance given various threats to the growth outlook, including from the US-China trade war, tensions with Iran and slower global growth generally, and a greater willingness by the Fed to take risks with higher inflation as opposed to deflation,” Mr Oliver said.

Both Mr Knightley and Mr Oliver also agreed that the rate cut would be the first of at least one additional reduction, with the Fed “leaving the door open” to further adjustments.

“The Fed never cuts rates just once, and we doubt it will this cycle,” Mr Knightley said.

“The language in the Fed statement is fairly vague and offers room for flexibility over coming months. It keeps in play what futures markets are pricing – at least another three rate cuts before the end of 2020.

“But, if anything, the statement (and vote outcome) offers more support to our more cautious outlook of only one further rate cut, most likely coming in September.”

Mr Oliver added: “Given that the risks to the growth outlook – particularly on trade – won’t go away quickly and that the Fed appears to have taken the decision that it’s easier to control a rise in inflation than a further slide or deflation, it’s likely to cut rates further and we are allowing for another cut in September.”

Fed cut unlikely to prompt RBA move

According to Mr Oliver, the Fed’s decision to cut its funds rate would not trigger an imminent cash rate reduction from the Reserve Bank of Australia (RBA), which cut the cash rate by a cumulative 50 bps in June and July to 1 per cent.

“The directional relationship between US and Australian interest rates weakened long ago,” Mr Oliver said.

“The RBA started raising rates in 2009 when the Fed held at zero, it was easing in 2016 when the Fed was hiking, and this year, it started cutting ahead of the Fed.

“So, just because the Fed moves doesn’t mean the RBA will as well.”

Mr Oliver added that the Fed’s move could help stimulative global economic growth, which would, in turn, support the Australian economy, but the AMP economist does not expect the stimulus to be enough to “change the outlook for the RBA”.

However, Mr Oliver remains of the view that the RBA will drop the cash rate twice by early next year, lowering it to 0.5 per cent, which he said would be partly motivated by the RBA’s preference for a lower Australian dollar that could be undermined by the Fed’s cuts.

[Related: Inflation spike takes ‘pressure off’ RBA]