3 factors that could impact U.S. monetary policy

On the latest edition of Market Week in Review, Quantitative Investment Strategist Dr. Kara Ng and Head of AIS Business Solutions Sophie Antal Gilbert discussed the U.S. Federal Reserve (the Fed)’s latest rate cut and the surge in oil prices.

Is another Fed rate cut possible this year?

Markets widely expected another Fed rate cut, and the central bank didn’t disappoint, lowering interest rates by 25 basis points to a target range of 1.75% to 2% on
Sept. 18, Ng said. What was less expected, she noted, was the level of dissent among Federal Open Market Committee (FOMC) members. Five of the 17 members were opposed to a rate cut altogether, Ng noted, while another five members were in support of the cut but viewed it as the last of the year. Only seven of the 17 members saw reason for an additional cut this year, she said.

Ng and the team of Russell Investments strategists’ rate outlook remains unchanged, however, with the team viewing an additional rate cut as likely by the end of 2019. “We think the Fed will lower interest rates enough to un-invert the U.S. Treasury yield curve, and at current market pricing, this translates to probably one rate cut—possibly at the end of October,” she explained. However, a lot can change between now and then, Ng emphasized, with several trade and economic developments possible that could guide future monetary policy. These include:

  • Institute for Supply Management (ISM) surveys, which provide information on the state of the U.S. manufacturing and services sectors. The U.S. manufacturing sector is currently contracting, Ng said. The ISM surveys for September, due out in early October, will shed light on whether this weakness has bled into the services sector, she noted.

  • The September employment report, which will be released by the U.S. Labor Department on Oct. 4, will also provide clues on the health of the economy. While U.S. corporations are currently struggling, the American consumer remains strong due to the strength of the labor market, Ng said. The upcoming employment report will show if businesses are starting to reduce hiring, she explained, adding that many corporations have already cut back on capital expenditures.

  • The high-level China-U.S. trade talks slated for early October. Trade is the swing factor that could either put the global economy back on course or tip it toward a recession, Ng said. “At the moment, there’s some hope that the next round of trade negotiations may possibly unwind the threatened tariff increases set for Oct. 15,” she stated, adding that an easing of trade tensions would be a positive for both the economy and risk assets.

    Ng noted that Chinese industrial production has slowed to its lowest level since 2012 due to the ongoing trade war. This deterioration in growth increases the likelihood that China will be more open to securing a trade deal with the U.S., as well as providing further fiscal stimulus, she stated.

“Overall, our current outlook is biased toward caution, but these upcoming events and data points could move the dial to both the upside or the downside,” she concluded.

Market and economic impacts of rising oil prices

Shifting to energy, Ng said that the Sept. 14 drone attack on a Saudi Arabian oil facility knocked out 5% of the global oil supply. This caused a spike in oil costs, with WTI (West Texas Intermediate) crude oil prices jumping 50% on Sept. 16 alone. As of
Sept. 20, oil prices have retreated about halfway from this peak, due to assurances from Saudi Arabia that it will move oil production back online relatively quickly and also tap into reserves in the interim.

While the attack was a geopolitical shock, it doesn’t pose any systemic risk to U.S. markets and the economy for a couple reasons, Ng said. “First off, the magnitude of the price spike is small in the content of history—it’s far too insignificant to trigger a recession,” she stated, “and secondly, the U.S.—the largest economy in the world—is now an oil producer.” The net effect of higher oil prices (within reason) is actually a benefit to the U.S. economy, she explained.

However, the increase in oil prices may negatively impact China, which is the globe’s second-largest economy, Ng said. “China is already relying on energy imports, and higher energy prices could worsen the country’s economic picture, which has already been negatively affected by trade tensions and the global growth slowdown,” she said.

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