Fed capitulating to the markets

With economic growth slowing rather than collapsing and both wage and price inflation rebounding in recent months, further interest rate cuts are hard to justify on purely economic terms. Admittedly, a further escalation of the trade war in the coming months could have a more marked impact on the economy. But, in isolation, the recently announced 10% tariff on $300bn of China’s imports should reduce GDP growth by only 0.2% points. And some of that drag will be offset by the devaluation of the Chinese renminbi. Nevertheless, we now expect the Fed to cut its policy rate by 25bp in September and again in December. The bottom line is that the Fed is in danger of losing control of the narrative to the bond market. Given its previous acquiescence to the bond market’s wish for a rate cut, we would be very surprised if officials began pushing back now.