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Better to travel than arrive?

The market is expecting a series of rate cuts, but it may be optimistic about how low rates will go.

The market is expecting a series of rate cuts, but it may be optimistic amount how low rates will go.

John Redwood

in Features


Markets have been going up on the expectation that interest rates will tumble. The Federal Reserve has changed its language this year and some market participants are hoping for a 0.5% cut in the US interest rate soon, with more falls to come. The announcement of Christine Lagarde as the EU Council’s preferred candidate for the European Central Bank led to forecasts of an even easier money policy in the Euro-area. The Bank of England relented a little from its tough rhetoric given the general mood and outlook, whilst the Australian Central Bank got on with a couple of rate cuts to take their official rate back down to 1%.

At the same time markets have been looking forward to some resolution of the trade row between the US and China. There was widespread relief that President Trump pulled back from imposing new tariffs on the remaining $300bn of Chinese exports to the US that are not yet covered by such levies, with some hoping that presages an eventual deal. Official talks are meant to resume in an attempt to deal with US worries about enforcement and Chinese concerns over how and when the current tariffs will be removed. The better the trade outlook becomes, the less likely the Fed will want big rate cuts.

Both bonds and shares have been going up. There is a danger in this. Bonds are rising because many in the bond markets think economies are going to slowdown too much, necessitating deep interest rate cuts to stimulate activity. Shares are going up because investors think we will avoid a recession, with the actual figures particularly, on the US economy, continuing to show growth in jobs, real incomes, consumption and activity.

What seems likely to happen is a world slowdown without a recession and some rate cuts, but not as many as quickly as the bond bulls like to forecast. There is a trend towards greater fiscal easing. Many electorates are tired of austerity and are pressing for tax cuts to boost their own personal incomes. There is also pressure to spend more on some essential public services. Infrastructure remains in vogue, with governments trying to find ways to finance better roads and railways, ports and broadband. There are limits to how far this can go, given the retention of tough budget rules in the EU and some continuing budget restraints elsewhere.

We are living through a manufacturing recession in parts of the world, exacerbated by the rapid change being demanded of the motor industry. The emphasis on electric vehicles has cut demand for conventional cars as people worry about present and prospective taxes and outright bans on the use of some diesel and petrol cars. The impact of technical change on retail is also considerable, with retail sales through shops hit by further moves to online. This has knock on negative effects for high streets and malls, and for retail staff.

We expect the world economy to muddle through, avoiding recession. We continue to expect some monetary easing and modest fiscal relaxation. We do not expect the scale of rate cuts some are claiming, given the fact that the US economy in particular is still generating reasonable growth. Some of the fiscal relaxation will only become apparent after the event, where countries under budget disciplines will end up overshooting their deficit limits because they have overstated tax revenues in their forecasts.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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