Investors have increased bets that the Federal Reserve will cut US interest rates not once but twice this year, to counter concerns about slowing global economic growth that have been inflamed by the worsening US-China trade war.
The probability that the central bank will cut rates two or more times by the end of 2019 rose above 48 per cent on Wednesday morning in New York, according to futures prices, exceeding expectations of a single cut.
The markets have been signalling a single rate cut this year for several months, even while the Fed has been keeping official policy on pause and maintained that its next move could be in either direction.
Concerns over the growth outlook have been roiling the bond market, helping push the US government’s borrowing costs lower as investors sought out the relative safety of Treasuries.
The benchmark 10-year Treasury yield, which moves inversely to price, fell 4 basis points on Wednesday morning to 2.22 per cent, marking its lowest level since September 2017.
“The economic data continues to weaken, exacerbated by a prolonged trade war with China,” said Quincy Krosby, chief market strategist at Prudential Financial. “That second rate cut is gaining traction because the market believes the economy will weaken.”
The US slapped additional tariffs on imports from China this month, and Chinese officials retaliated with measures of their own. President Donald Trump warned on Monday that US tariffs on goods from China could still “go up very, very substantially, very easily”.
The signal from the widely watched US yield curve, whose inversion has been a reliable indicator of past recessions, also intensified investor nervousness on Tuesday, because long-dated Treasury yields slid further below yields on shorter-dated government debt.
The difference between three-month and 10-year Treasury yields dropped minus 13 basis points, its lowest since August 2007. This measure of the yield curve has turned negative before every US recession of the past 50 years.
Citi’s global economic surprise index, which measures whether data are coming in better or worse relative to expectations, has been in negative territory for more than a year — its longest stint below zero on record. That has led analysts to pare their forecasts for global growth this year, to a median estimate of 3.3 per cent in 2019. This would be the slowest rate of expansion since 2009.
Analysts at Morgan Stanley warned that, after adjusting for the effects of the unprecedented unwinding of the Fed’s post-financial crisis bond-buying programme, the yield curve has effectively been inverted since November 2018.
“We think this means the US economic slowdown and rising recession risk is happening regardless of the trade outcome,” the equity strategists, led by Michael Wilson, wrote.
The Fed has avoided any indication that cuts are coming. Minutes of its most recent meeting, held on April 30 and May 1 before the latest round of tit-for-tat tariffs were announced, suggested that there was no immediate plan to move interest rates either higher or lower. Speeches from policymakers in recent weeks have reiterated the central bank’s “patient” approach.
In spite of the Fed’s stance, investors are anticipating that the central bank will have to ease its monetary policy.
“One cut is likely. I would not be surprised if we see two,” said Kristina Hooper, chief global market strategist at Invesco. “A lot of it depends on how much of a deterioration we see in the economic data. But just the breakdown in relations between the US and China is good for one rate cut.”
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