US economy is slowing down

US economy slowing down


The US economy is slowing, but will the US Federal Reserve cut rates?

Justin Still

Justin Still

Up until December 2018, the United States Federal Reserve had been trying to gradually increase interest rates and slow the economy.

Most estimates were that this slowdown would finally arrive in the second half of this year.

The slowdown now seems to have arrived in the second quarter.

After growth of 3.1 per cent annualised GDP growth in the first quarter of this year, there are signs that the US economy is slowing and is likely now only growing at 2pc.

Bluechip consensus (which is the best US economic forecasters in the market) says that growth will continue to slow throughout the year to between 1.8pc-1.9pc.

Should these slower rates of growth continue into next year, what you'll see is that employment will be growing slower than the growth in the labour force.

This means that US unemployment would initially continue to decline until about October-November this year to around 3.5pc and then gradually drift up next year to a level around 4.3-4.5pc.

At that point, the Fed would want to stabilise what's happening in the economy by cutting rates.

The Fed is unlikely to cut rates before unemployment begins to rise next year.

Right now, our model of US interest rates suggests that the Fed funds rate of 2.25pc is too high.

Despite this, we think the Fed will not cut rates yet, because we believe it would probably have to reverse the cut soon after.

In the last two cycles the Fed funds rate has peaked 1.6pc to 1.7pc higher than our modelling.

Now it's only 68 basis points higher than our model, which isn't enough in the demonstrated history of how the Fed behaves for it to cut rates straight away.

At present, we have an inversion of the US yield curve (longer term rates lower than short term rates).

Inverted yield curves don't go on forever. They go on for a few quarters at most.

What always happens after the yield curve inverts is that inflation works its way through into the market, which will happen in the US with unemployment rates so low.

In summary, the US economy is slowing down.

Our model suggests that there is room for a rate cut.

Still, it's not enough compared to previous cycles to compel the Fed to act yet.

We think the Fed will stay where it is and look for more information to emerge.

So far, their plan of slowing the economy to a moderate pace of growth is working surprisingly well.

  • Justin Still investment adviser (Authorised Representative: 000279726) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410

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