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Does The Latest U.S. Inflation Report Strengthen The Case For Another Rate Cut?

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by: Russell Investments
Summary

Positive developments reported in China-U.S. trade negotiations.

U.S. consumer prices unchanged in September.

Fed to boost size of balance sheet.

On the latest edition of Market Week in Review, Quantitative Investment Strategist Abraham Robison and Research Analyst Puneet Thiara discussed recent developments surrounding China-U.S. trade negotiations, the latest report on U.S. inflation and the U.S. Federal Reserve's (the Fed) announcement that it will increase the size of its balance sheet.

Markets rise on positive news surrounding trade, Brexit

The latest round of trade negotiations between the U.S. and China kicked off Oct. 10 in Washington D.C. So far, the talks have been positive, Robison noted, with the possibility that the U.S. will scrap a planned Oct. 15 tariff increase on Chinese goods. In addition, China may commit to purchasing more soybeans from the U.S., and the two nations may also strike a deal that would prevent currency devaluation.

"All in all, this is modestly positive news," Robison said, adding that both the S&P 500® Index and the Dow Jones Industrial Average were up over 1.5%, as of mid-morning Oct. 11 Pacific time, on the news.

He also noted that the latest developments surrounding Brexit appear positive as well, with negotiators from the European Union and the UK expressing optimism that a potential divorce deal may come together prior to the UK's scheduled departure date on Oct. 31.

Soft September inflation numbers increase odds of Fed rate cut

The U.S. Consumer Price Index (CPI) for September, released Oct. 10 by the Labor Department, came in a bit on the soft side, Robison said. "The CPI was flat in September, with consumer prices unchanged-which means there wasn't much inflation," he explained. This reading strengthens the case for the Fed to cut interest rates for a third time this year at its upcoming Oct. 29-30 meeting, Robison said. "In our view, there's probably an 80% chance that the Fed will do just that," he noted, adding that another rate cut would help send equity markets higher.

Fed to increase balance sheet by buying Treasury bills

The Fed announced on Oct. 11 that it will increase the size of its balance sheet by purchasing short-term Treasury bills starting Oct. 15, Robison said. While this may look similar to the quantitative easing (QE) program started by the central bank to combat the Global Financial Crisis, it's clearly not QE, he stated.

"QE involved purchasing longer-term bonds and mortgage-backed securities. This deals with purchasing normal short-term Treasuries in order to remedy last month's rate spikes in money markets," Robison explained. The key takeaway here, he concluded, is that this amounts to normal operations by the Fed to try to stabilize the demand for money.

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