Trouble ahead in the US – interest rates have further to fall

Interest rates have further to fall on both sides of the Atlantic if you read the runes of what the central bankers are saying – and not saying.

In the US, the Federal Reserve cut interest rates by 25 basis points on Wednesday for the second time this year while the Bank of England kept rates on hold at today’s meeting.

The Fed cut was not big enough for President Trump who immediately tweeted that: “[Fed chairman] Jay Powell and the Federal Reserve Fail Again. No “guts,” no sense, no vision! A terrible communicator!”

Yet that’s not what market experts drew from Powell’s statement. Quite the reverse. Most US economists are now predicting that Powell and his Fed board, despite being deeply divided over the latest cut, could be ready for another two cuts by the end of the year to help relieve trade uncertainty and any slowdown in world growth. Rate cuts had not been expected until next year.

Although Powell’s comments were not much different from what he said in July – that the Fed would “act as appropriate to sustain the expansion” – his tone was markedly different. Indeed, there enough hints for the markets to interpret that he is ready to cut rates again if the global economy continues to slow down.

It wasn’t quite as dramatic a moment as the ECB’s Mario Draghi’s Big Bazooka – “or whatever it takes” statement, but was enough to cheer up the equity markets.

Some commentators went as far as describing Powell’s words as surprisingly “doveish,” that the Fed boss is learning to speak “Yellandish and Bernankish”. In other words, he is starting to give the direction of travel.

And that’s what US investors and traders crave: some certainty amid the chaos of a worsening trade war with China and concerns over a Middle-East flare-up between Iran and Saudi Arabia.

David Zervos, the influential chief market strategist at Jeffries, says Powell’s cut, together with his words, has created a “backstop” style type insurance policy for the US stock markets.

Or as he put it: “The Fed is saying … we are backstopping this.” Good luck with that.

Zervos is interesting to listen to as he takes a more contrarian view than most US economists. He reckons that any faltering in economic growth in the US and globally, is due more to the Fed’s tightening of monetary policy a few years ago – and which is now being felt – than the impact of business uncertainty over Trump’s trade spat with China.

Whether you like it or not, this could be the lightbulb moment that Trump wants from the Fed on interest rates, which range up to 2%. He wants them slashed to sustain domestic demand, which by all accounts is strong with near full employment and buoyant consumer spending.

There’s no doubt the Fed’s decision was influenced by the antics earlier this week in the repo market when the repo rate – the cost of short-term lending between banks – spiked on Monday night.Usually, around $1 trillion of funds are channelled through Wall Street’s repo market ( otherwise known as repurchase agreements) every night to ensure that banks and hedge funds can pay each other.

But interest rates have been shooting up to as high as 2.3%, much higher than normal and above the Fed’s target, forcing the Fed to channel emergency dollars into the market to ensure enough liquidity in the system.

Policy-makers are denying that there is anything sinister behind these liquidity problems. Even so, the New York Fed acted quickly to pump more than $125bn into the markets to prevent any cash shortages – the first time it has done so since the financial crash.

Together with the rate cut, the Fed’s intervention bought time, and confidence and cheered the equity markets.

Here in the UK the BofE’s Carney said that Brexit uncertainty, coupled with a slowdown in global growth, might warrant further interest rate cuts. It was hardly an endorsement but he urged the government to get on with Brexit, claiming that any delay beyond October 31 would be harmful. Talk about stating the obvious but what else can he say?

And if there is no deal ? Well, the Bank expects sterling to fall, inflation to rise and growth to slow down. In that event, interest rates would fall or rise, depending on what is needed most. If there is a smooth deal, rates might rise again.

In other words, anyone trying to divine the Brexit outcome is as mad as a hatter.

Yet Carney’s tone was also more doveish, suggesting that interest rates could stay flat for sometime whatever the outcome. That sounds like another backstop for sterling which was back up against the euro in a three month high. Investors are betting there will be a deal. They may be right.