Advisory Blog
Trade truce, weakening economic data cloud Fed

Timely insights on the issues that matter most to investors.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

  • All Posts
  • More
    Topics
      Authors

      Filter Insights by Date:   Start Date   End Date   or  Show recent results
      The article below is presented as a single post. Click here to view all posts.

      By Eric Stein, CFACo-Director of Global Income, Eaton Vance Management and Andrew Szczurowski, CFAPortfolio Manager, Global Income Group, Eaton Vance Management

      First in a three-part series

      Boston - At the Group of 20 (G20) summit in Japan, the U.S. and China agreed to resume trade talks, with both sides offering concessions. While this temporary cease-fire may cause the Federal Reserve to reverse recent signals that rate cuts could come soon, other factors, such as weakening economic data, could cause the Fed to follow through on cutting the fed funds rate later this month. The Advisory Blog recently sat down with Eaton Vance portfolio managers Eric Stein and Andrew Szczurowski to get their take on where Fed policy stands today - and what it means for markets and investors.

      What is the biggest factor guiding Fed policy today?

      Andrew: I think the main driver that has caused the about-face from the Fed, going from rate hikes to rate cuts is the trade war; primarily with China, but trade uncertainty with Mexico and Europe has also been a factor.

      We are seeing two diverging trends right now in the U.S. economy: Trade uncertainty is hurting business confidence, while consumer confidence remains at very elevated levels thanks to a tight labor market and rising wages. The most important question going forward is, will these trends persist and which one will have a greater impact on growth going forward.

      If you are a U.S. based multinational-corporation and you don't know if there are going to be 10%, 25% or 0% tariffs on your supply chains and the goods you sell overseas, it is very difficult for you to have the confidence to build a new factory, or increase your capital expenditures in general. I think the Fed is closely watching this deteriorating business confidence and believes they need to act with an adjustment in monetary policy.

      Would a rate cut in July jump-start the U.S. economy?

      Andrew: I don't really think the U.S. economy actually needs a jump start. We are talking about an economy that just had its strongest GDP growth since 2005, unemployment at 50 year low, and a stock market at all-time highs. It seems likely that GDP growth will slow back down to its potential growth rate in the low 2% area and that's OK. The U.S. economy doesn't just have to go from growing 3% to negative 1%, there is plenty of space in-between where growth can shake out. People forget that the U.S. economy grew at an average of 2.17% for the first 8 years of the economic recovery, 2018 was really the anomaly.

      As far as the impact a rate cut would have on the U.S. economy.... Given my view that the trade war is the biggest driver of economic uncertainty, I don't see how cutting rates 25 or 50 basis points solves that issue. At the end of the day rate cuts are not a panacea for all that ails the world, like some central banks may think. If anything, rate cuts could prolong the trade war by giving the administration ammunition — in the form of higher stock markets and tighter credit spreads.

      Eric, do you agree that the Fed's decisions are inextricably tied to the outcome of trade negotiations?

      Eric: I have a slightly more dovish take than Andrew does, as I disagree with him that the Fed's dovishness is 100% dependent on the trade war. For sure, a good trade outcome makes the Fed incrementally less dovish; a bad trade outcome fuels more dovishness.

      However, I'm more focused on the structural shift we're seeing. There is a real focus on why the Fed isn't hitting its inflation target. I do not think 2% inflation is some magic number, nor do I think 1.5% or 1.7% is bad, as some at the Fed and in academic circles think. Regardless of what I think about the merits of a 2 percent inflation target, the Fed is starting to focus a lot more on its chronic undershooting of that 2 percent inflation target. Also, the cyclical data that has probably slowed post-fiscal stimulus from a year ago, combined with an unpredictable trade war, I think the Fed, as it has signaled, has an easing bias.

      So it seems that the path of least resistance is easing. The debate now is really whether the Fed cuts 25 or 50 basis points in July and what it should do after that.

      Another factor driving the Fed's dovishness is concern about the zero lower bound because the Fed's pretty close to zero interest rates versus history. Zero lower bound is a situation that when the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the capacity that the central bank has to stimulate economic growth.

      Although, the Fed is far-off from that scenario compared to other developed-market central banks. The Fed doesn't want to go to zero, at which point they might have to do more quantitative easing (QE) or go negative. So they'd rather be somewhat pre-emptive in cutting rates. As Andrew says, the strength of the US economy — where we are in the labor market and the consumer side — is very, very strong. It is just the relative deltas are shifting to a slowdown.

      Historically, maybe a pause would be warranted — but right now, I think the Fed believes it needs to ease, potentially aggressively because they don't want to face the issues at the zero lower bound.