US rate cuts loom as the FOMC debates options, with Canada poised for further reductions too
Larry Berman, in an opinion piece reported by BNN Bloomberg, anticipates that the US Federal Open Market Committee (FOMC) might begin discussing a significant rate cut, possibly starting with 50 basis points (bps).
This expectation is driven by recent signs of softening in both employment and inflation. However, the FOMC may choose a more moderate approach, favouring the typical 25 bps cuts, which align better with their standard practices.
The argument for a larger cut in September stems from concerns that the FOMC may currently be behind the curve.
On August 5, amidst growing calls for emergency rate cuts, the market had been pricing in a 50-bps cut. By the end of last week, this likelihood had decreased, with only a 30 percent chance of a 50-bps cut and a 100 percent probability of a 25-bps cut.
Although no official FOMC meeting is scheduled at Jackson Hole, Federal Reserve Chair Jerome Powell is expected to offer updated insights on August 23 at 10 am.
As of last Friday, US futures markets were pricing in eight 25 bps rate cuts over the next year, which could bring the overnight rate down to 3.5 percent.
This rate would still be notably higher than the current inflation levels, suggesting that such an aggressive reduction might be unlikely unless the economy faces a harder landing.
Berman also notes that base inflation rates are likely to remain above the two percent target for an extended period. He warns that too much stimulus could risk pushing inflation higher again.
Given the existing deficits and the increasing cost of servicing debt, it’s unlikely that future US administrations will offer the same level of fiscal stimulus seen previously. Meanwhile, the cost of debt financing is expected to grow relative to the economy’s size.
In Canada, the Bank of Canada has already cut rates by 25 bps twice and has six more cuts priced in by mid-next year. This scenario appears more plausible due to Canada’s structurally weaker economy compared to the US, both in recent years and moving forward.
Berman suggests that while markets have rebounded from recent panic, a consolidation of gains is more likely than continued growth. He believes that earnings expectations may be overly optimistic given the anticipated economic growth in the coming years.
The bond market, which signals a hard landing, contradicts the more optimistic outlook of the stock market. Berman expects that companies sensitive to falling rates may perform better in the near future compared to growth-oriented companies that are currently more fully valued.
