Trade worries Distract From Difficult Truths

Markets will have been looking towards this week with a certain amount of dread. Britain was supposed to have exited the EU on 31 October – for better or for worse – and we were expected to be dealing with the fallout. The can, however, has been kicked down the road once more.

US cuts rates
In a well-signposted move, the Fed’s Open Market Committee chose to trim its headline policy rate by a further 25bps at the 30 October meeting. That makes for the third cut in a row, with previous ones having been made in July and September by similar amounts.

The 8:2 split in favour of the latest move suggests there is still a degree of dissent among committee members. This is a stark contrast to the unanimous consensus of 2018, when the Fed was raising rates. It will be interesting to see how the balance shifts in the months ahead. For the time being, Governor Powell is playing coy.

In its latest statement, the FOMC softened the tone slightly, leaning less on hawkish language. The plan is now to “assess an appropriate path” for rates. Careful not to take further cuts off the table, policymakers will no doubt be conscious of keeping some spare capacity in reserve should a more severe downturn materialise. They’d rather not end up in the same situation as the ECB.

Based on historical experience, 75bps seems to be the right level for previous cycles of “insurance cuts”, helping to deliver a bump to economic growth. That said, the dynamics are somewhat different than those faced by officials in the 1990s.

BoE up next
It will be a more clear-cut decision for the BoE this week.

Immediate risks around Brexit have subsided, the MPC is likely to keep its powder dry and rates will remain at 0.75%. The markets certainly seem to agree, with the chances of a rate hike by year end having fallen from c. 40% at the height of no-deal chatter (10 October) to just 10% today, according to Bloomberg.

US rate cuts will have helped too, narrowing the gap between policy on either side of the Atlantic and putting the BoE’s patience into a more favourable light.

The UK election will now be the largest risk on the horizon for the Bank. A Conservative win would likely mean rates stay where they are. A Labour coalition and subsequent referendum could increase the possibility of Remain, with a pickup in business investment, and even a rate hike. A hung parliament could be anywhere in between, perhaps even a rate cut if political limbo continues and growth remains tepid.

Trade and Brexit worries obscure the outlook
Both banks are dealing with similar issues and there is a risk that trade concerns and the Brexit backdrop are distracting us from the underlying economic reality.

For all the talk about 3% developed market growth targets, perhaps policymakers will have to wise up to a new normal in terms of economic performance; namely lower growth, lower inflation, higher debt, and lower unemployment for the foreseeable future.

Few would suggest that western economies are going the way of 1990s Japan, but policy may be due a more fundamental rethink if it’s to remain relevant. Perhaps that could even mean a less active role for central banks going forward.

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