Fed funds rate likely to go down by 25bps each in September and December, says DBS Group Research

The Fed Funds rate is expected to go down by 25bps each in September and December, to be explained as insurance against global market risks and chronically below-target inflation, according to the latest report from DBS Group Research.

The fixed income market is pricing in a series of rate cuts nonetheless, predicated on the potential for lasting damage to the global economy from prevailing uncertainties, as well as the view that the real policy rate is too high at a time of ballooning downside risks and chronically below-target inflation.

From the US Federal Reserve’s perspective, it will become progressively difficult to ignore the market dynamics and pipeline economic risks, according to the report.

The outlook for 2020 is exceptionally cloudy, as some sort of a resolution in China-US tensions could boost sentiments on one hand, whereas rising pass-through from higher tariffs could create a stagflation-type scenario on the other hand, constraining Fed policy.

The Fed’s motivation to cut rates would stem from the need to be seen doing something, and the notion that lowering real rates would help soothe the credit channel at a time if heightened risk aversion.

That the policy rate cut could come in less than three months from now also implies that Fed policy would not be pursued in response to data releases, which may well remain broadly fine for the US in the near term.

"A hint or two on growing inventories, further unrest in global financial markets, and a worsening of inflation expectations would be sufficient, in our view," the report added in its comments.