Fed set to cut interest rates for first time in 10 years

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Fed set to cut interest rates for first time in 10 years
Federal Reserve Board Chairman Jerome Powell arrives at a hearing before the Senate Banking, Housing and Urban Affairs Committee July 17, 2018 on Capitol Hill in Washington, DC. - The Federal Reserve will continue to raise rates gradually as the economic outlook remains strong despite uncertainty over trade policy, Federal Reserve Chairman Jerome Powell said Tuesday. (Photo by ANDREW CABALLERO-REYNOLDS / AFP) (Photo credit should read ANDREW CABALLERO-REYNOLDS/AFP/Getty Images)

The US Federal Reserve is poised to cut interest rates for the first time in a decade when it meets this week in a preemptive effort to stave off the effects of trade tensions. 

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Market players think it is certain that the Fed will cut rates. Based on trades, the implied probability of a 25 basis point (0.25 percentage point) cut on Wednesday is 79 per cent, according to closely-watched gauge from CME Group.

Traders think there is a 21 per cent chance of a deeper cut of 50 basis points or 0.5 percentage points.

It would be the first rate cut of the federal funds rate since the US central bank slashed borrowing costs in the wake of the financial crisis to 0.5 per cent. An interest rate cut makes borrowing cheaper and encourages spending, which is likely to boost the economy.

The Fed then raised its main rate from the post-crisis level in early 2016 to between 2.25 and 2.5 per cent by the end of 2018, where they have since stood.

However, the US’s ongoing trade war with China and signs of slowing growth have darkened policymakers’ mood. This has made the Fed’s rate-setting committee eye a cut despite the US economy growing faster than most other developed nations and unemployment standing at record lows.

Barclays analysts Michael Gapen and Jonathan Millar said that “a slowdown in the industrial sector on the heels of slower growth momentum abroad, increased uncertainty from trade and other unresolved government policy issues” are all factors.

“The desire to insulate the US outlook from weaker growth in some foreign economies and elevated policy uncertainty has all the classic markings of ‘insurance’ cuts.”

Paul Ashworth, chief US economist at Capital Economics, said: “If the Fed does opt to cut rates by a modest 25bp next Wednesday, it could be in for some criticism before the end of the week if the key incoming data show further weakness.”

He highlighted that the Fed meeting comes a week after the European Central Bank (ECB) disappointed the markets by not cutting interest rates. 

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“We expect a further slowdown in economic growth to prompt two more 25 basis point cuts, in December and March next year,” Ashworth said.