Danske Bank thinks US Fed will slash rates to one per cent by March
Denmark’s biggest bank has predicted that the US Federal Reserve will slash its interest rate down to one per cent by March 2020.
Danske Bank said it expects five more 25 basis point (0.25 percentage point) cuts between now and the Fed’s March 2020 meeting to “reflate the economy and markets”.
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If the Fed were to carry out such drastic cuts it would be a rapid reduction of the gradual interest rate rises the US central bank carried out between the start of 2016 and the end of 2018.
At its July meeting the Fed cut interest rates by 25 basis points to between two and 2.25 per cent. Chair Jay Powell called the reduction a “midcycle adjustment” and said it was to insure against an escalation in the US-China trade war and a possible economic downturn.
In a note released today, Danske said: “Since the meeting, we have seen an escalation of the US-China trade war… and risk sentiment become shakier.”
Danske analysts pointed to the inversion of the so-called government bond yield curve, whereby yields – the interest holders receive – on 10-year US government bonds (called Treasuries) fell below those on two-year Treasuries.
An inversion is rare and is widely seen as heralding a recession as it shows investors think a downturn is coming, which is why they pile into the higher-yielding end of bond markets.
“Economic indicators outside the US have been weak, with weaker-than-expected Chinese data for fixed asset investments, industrial production and retail sales,” Danske analysts said. They also highlighted Germany’s contraction in the second quarter.
“Despite our new, more aggressive Fed call, we do not expect the Federal Reserve to pre-commit to further easing but instead expect it to stick to its current ad hoc approach, at least in the near term.”
Markets think the Fed will cut rates less drastically over the coming year and a half, said Paul Ashworth, chief US economist at Capital Economics.
Ashworth said: “The futures market is now pricing in more than 100 basis points of additional rate cuts from the Fed by end-2020, including 50 basis points over the remainder of this year.”
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“There is a risk Powell and his colleagues end up disappointing the bond market next week”, when they meet for their annual symposium in Jackson Hole, “by not signalling clearly enough that additional rate cuts are coming in mid-September and beyond,” Ashworth said.
“That could trigger carnage in the bond and equity markets.”