Posted August 2, 2019
After beginning its interest rate tightening cycle in December 2015, on July 31st the Federal Reserve voted to reduce its policy interest rate by 0.25% to a range of 2-2.25%. This is the first time the Fed has cut the policy rate since late 2008. While a rate cut was widely expected by the markets, investors were seemingly hoping
for either a larger cut, or the promise of a series of future reductions. Yields on some shorter-term U.S. treasuries actually increased immediately after the Wednesday announcement, while the S&P 500 index fell 1.09% for the day. Most of this decline occurred after Fed Chairman Powell indicated this was a one-time decrease and not part of a plan to continue cutting rates.
The Fed indicated their primary concerns are trade tensions and weak growth overseas, which have impacted US economic growth. The Commerce Department revised Gross Domestic Product (GDP) growth for all of 2018 down from 3% to 2.5% and, at the end of July, it announced that GDP rose at annual rate of 2.1% in Q2 of 2019. Overseas growth is also slowing. While a trade deal between the U.S. and China would not only assist the U.S. expansion and improve global demand, trade talks do not appear to be moving in that direction. After Treasury Secretary Mnuchin and U.S. Trade Representative Lighthizer returned from trade talks in Shanghai without much progress to report, President Trump announced a 10% tariff on an additional $300 billion of Chinese imports and committed to planned trade discussions in September. If the September trade talks fail to produce meaningful progress, the US economy is expected stay in a phase of modest GDP growth of around 2%. More tariffs in September are also a possibility, but President Trump has an incentive to preserve the U.S. economic expansion as his reelection campaign comes into focus.
Vigorous Consumer Spending Keeps the U.S. Expansion Going
In justifying a single 0.25% rate cut, Chairman Powell reiterated the Fed’s view of continued favorable domestic economic conditions. The U.S. economy still benefits from strong job growth, increasing wages, low interest rates, low inflation and healthy consumer spending. Consumer spending makes up 70% of the U.S. economy and American consumers just produced four consecutive months of rising retail sales. The late July budget deal between Trump and Congress removes the risk of another government shutdown and a standoff over the debt ceiling.
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