On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben and Research Analyst Brian Yadao discussed the recent rate cut by the U.S. Federal Reserve (the Fed) and the potential impact of additional U.S. tariffs on Chinese goods.
Fed cuts interest rates by 25 basis points, citing trade tensions and global economic slowdown
As expected, the Fed lowered its benchmark interest rate by 25 basis points on July 31, yet the immediate market reaction following Chairman Jerome Powell's press conference was negative. Why? Powell stated that the cut did not mark the beginning of a long series of rate reductions, Ristuben noted-which initially cast some doubt about the likelihood of future cuts.
"The likely reason behind Powell's remark is that, historically, the Fed only embarks on a series of rate cuts when it strongly believes the U.S. economy is rolling over into a recession - and today's economy is still on fairly solid footing," Ristuben stated, adding that the central bank did not want to convey a panicked tone.
The Fed chair was able to walk a fine line by casting the rate cut as an insurance cut that would help buffer the economy against trade tensions, waning CEO confidence and a slowdown in global manufacturing activity, he noted. "I believe the Fed wanted to provide a reason for individuals to believe that the current economic expansion can be maintained," Ristuben said, "and the central bank did this by cutting rates." Markets ultimately bounced back the morning after the cut, wiping out most of the previous day's losses, he noted - that is, until the China-U.S. trade war sharply escalated.
Additional tariffs may weaken U.S. consumer spending, job growth
U.S. President Donald Trump's Aug. 1 announcement that the U.S. plans to impose a 10% tariff on an additional $300 billion worth of Chinese goods in September roiled markets, with the S&P 500® Index down roughly 3.5% on the week, as of mid-morning Pacific time on Aug. 2. The negative market reaction was likely due to three main reasons, Ristuben said:
- The expected detrimental impact of additional tariffs on corporate earnings.
- The potential for additional tariffs to harm consumer spending.
- The potential for a slowdown in hiring due to the tariffs.
Tariffs weaken corporate earnings because they result in an increase in input costs, he stated, pointing to the negative impact that currently imposed tariffs have already had on U.S. earnings this year. Potentially just as problematic is that the $300 billion worth of Chinese imports targeted by these latest tariffs consists mostly of consumer goods, Ristuben noted. "This means consumer spending, which accounts for approximately 70% of the U.S. economy, may be impacted more," he said.
Even potentially more worrisome, in Ristuben's opinion, is the impact the tariffs could have on the country's labor market. "Already, CEOs who have lost confidence in the economic outlook due to the trade war are buying capital goods at a lesser rate," he said, "and typically, the next step they'll take in situations like this is to cut back on hiring." There's already been a gear-shift in U.S. employment this year, he said, with monthly job gains dropping from roughly 225,000 per month in 2018 to 175,000 per month so far this year. "This slowdown in jobs was expected-and is currently not a problem," Ristuben stated, "but if we see another downshift, the job market will likely become a growing concern."
Will the Fed cut rates again in September?
The latest tariff threat from the U.S. strongly increases the chances that the Fed will slash borrowing costs again at its September meeting, Ristuben said. "Powell noted in his press conference that one of the reasons for the July rate cut was to offset the potential impacts of trade uncertainty - and now, just days later, the amount of trade uncertainty has risen sharply," he remarked.
The debate among market participants ahead of the Fed's Sept. 17-18 meeting will likely revolve around whether the central bank will slash borrowing costs by 25 or 50 basis points, Ristuben said. "At Russell Investments, we think that a 25-basis point cut looks more likely right now, but there's a lot of time - and a lot of new economic data to be released between now and mid-September," he noted. All things considered, Ristuben and the team of global strategists remain of the viewpoint that the U.S. is not rotating immediately into a recession. "Make no mistake, however - things are getting more and more interesting," he concluded.
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.
Investing involves risk and principal loss is possible.
Past performance does not guarantee future performance.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
This material is not an offer, solicitation or recommendation to purchase any security. Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.
The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional. The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.
Please remember that all investments carry some level of risk. Although steps can be taken to help reduce risk it cannot be completely removed. They do no not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Investments that are allocated across multiple types of securities may be exposed to a variety of risks based on the asset classes, investment styles, market sectors, and size of companies preferred by the investment managers. Investors should consider how the combined risks impact their total investment portfolio and understand that different risks can lead to varying financial consequences, including loss of principal. Please see a prospectus for further details.
Indexes are unmanaged and cannot be invested in directly.
The S&P 500® Index, or the Standard & Poor's 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ.
Russell Investments' ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments' management.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the "FTSE RUSSELL" brand.
Copyright © Russell Investments Group LLC 2019. All rights reserved.
This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty.