Fed Cuts Rates as Downside Risks Build - Title Image

Fed Cuts Rates as Downside Risks Build

The U.S. economy is strong, but soft inflation and downside risks to growth prompted the first Fed rate cut since 2008.

August 22, 2019


This Macroeconomic Outlook report is excerpted from the Third Quarter 2019 Fixed-Income Outlook.

U.S. economic growth slowed to 2.1 percent annualized in the second quarter from 3.1 percent in the first quarter. Personal consumption expenditures (PCE) rebounded sharply, as expected, while government spending contributed an outsized 0.9 percentage point to growth, the most since mid-2009. However, negative contributions were seen from housing, business capital expenditure, inventory investment, and net exports. Looking ahead, we expect the economy to grow at a 1.5–2.0 percent pace in the third quarter.

The second-quarter gross domestic product (GDP) release also featured annual revisions to the five prior years of data, which showed that growth peaked in year-over-year terms in the second quarter of 2018, earlier than previously thought. An upwardly revised personal saving rate gives consumption room to run, but downwardly revised and shrinking corporate profits will continue to pressure investment spending and could begin to weigh more heavily on hiring.

Latest GDP Data Shows Growth Peaked Earlier Than Thought

Real GDP, YoY% Change

The second-quarter GDP release featured annual revisions to the five prior years of data, which showed that growth peaked in year-over-year terms in the second quarter of 2018, earlier than previously thought.

Latest GDP Data Shows Growth Peaked Earlier Than Thought

Source: Guggenheim Investments, Haver Analytics. Data as of 6.30.2019.

With growth in the first half of the year coming in somewhat above potential, the labor market continued to strengthen, albeit at a slower pace than the year before. Net monthly payroll gains averaged 141,000 in the six months through July, down from 236,000 during the same period in 2018. This was enough to push the unemployment rate down by 0.2 percentage point to 3.7 percent. While the labor market remains strong, we believe the sharp slowdown in aggregate hours worked—a component of our U.S. Recession Dashboard—foreshadows a deterioration in labor market conditions in 2020.

After a weak start to the year, core inflation picked up in the second quarter but remained below the Fed’s 2 percent target at 1.8 percent annualized. We expect inflation to firm a bit further in the second half of 2019.

Although the U.S. economy is in good shape overall, on July 31 the Fed announced its first rate cut since 2008 amid growing downside risks to policymakers’ baseline growth and inflation forecasts. Key among these are slowing global growth, the threat of additional U.S.-China tariffs, and a possible hard Brexit, the odds of which have increased with the ascendance of Boris Johnson as prime minister of the United Kingdom. While a possible U.S. fiscal contraction in 2020 was averted by the recently signed budget deal, we expect two more Fed rate cuts in 2019 as Chair Jay Powell seeks to sustain the expansion. In our view, this could serve to embolden the White House to impose new tariffs on China and Europe later this year, which would in turn further cloud the outlook for global growth.

Mounting Downside Risks Drive the Fed into Easing Mode

Net Upside/Down Risk to SEP Projections: % of FOMC Participants

Although the U.S. economy is in good shape overall, on July 31 the Fed announced its first rate cut since 2008 amid growing downside risks to policymakers’ baseline growth and inflation forecasts.

Mounting Downside Risks Drive the Fed into Easing Mode

Source: Guggenheim Investments, Federal Reserve. Data as of 6.19.2019.

—Brian Smedley, Head of Macroeconomic and Investment Research; Maria Giraldo, CFA, Managing Director; Matt Bush, CFA, CBE, Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.

©2019, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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