Rising Possibility of Interest Rate Cut in 4Q19 or 1Q20, in Our View

The US Federal Reserve (US Fed) left its Federal funds rate (FFR) unchanged in the range of 2.25-2.50%, as expected, where it has been maintained at this range since its last 25bps rate hike in the December FOMC meeting. In the latest assessment, the US Fed made some changes and turning slightly more cautious in the statement on the economic outlook as it guided that economic activity is rising at a moderate pace compared to “solid pace” in its previous statement in May. Furthermore, it guided that although it still expects sustained expansion of economic activity, “uncertainties about the outlook have increased”. Notably, the word “patient” was removed from this statement as the Fed now guides it “will act as appropriate to sustain the expansion”. On the inflation front, despite inflation rates remaining at weak levels with core-PCE staying below the 2% inflation target since the start of the year, the US Fed continued to believe that “inflation near the Committee’s symmetric 2% objective” is the most likely outcome.

Therefore, with the US Fed making some changes in the language to the policy statement, signalling a dovish tone on the US economy, we believe this paves the way for a potential 25bps rate cut in 4Q19 or 1Q20 to 2.0- 2.25%. The US Fed has not cut rates since December 2008 when it slashed rates by 75bps from 1% to a range of 0-0.25% in an effort to boost the economy. According to the latest dot plot, the Fed does not expect any rate cuts this year but projects one rate cut in 2020. This compares to the previous dot plot in March when it projected no policy changes in 2019 but one rate hike in 2020. However, we believe if incoming information indicates softer US economy, then a reduction in the target range for the federal funds rate is likely to occur sooner than currently anticipated.

As for the expectations of policy in the renewal of quantitative easing (QE) program by US Federal Reserve, we believe that as risk of sharp decline in economic activity (i.e. recession) or deflation is unlikely to happen in the near term, the current economic conditions may not influence US Fed to introduce new quantitative easing from the current arrangement. Recall that in the FOMC Meeting in March, the Fed guided that starting May 2019, the amount of Treasuries allowed to mature without reinvesting will drop to US$15bn compared to US$30bn previously. The balance sheet reduction will also conclude by September 2019.

In the latest FOMC Summary of Economic Projection, the Fed also lowered its GDP growth forecast from the March FOMC meeting, from 1.9-2.2% to 2.0-2.2% in 2019. The unemployment rate is projected to be slightly lower with a downward revision to 3.6-3.7% from 3.6-3.8%, previously. On the inflation outlook, the median expectation of PCE inflation was lowered by 0.3 percentage point to 1.5% from 1.8% while core PCE inflation projection was also cut to 1.8% from 2% previously.

Source: Affin Hwang Research - 20 Jun 2019