In our view, US domestic economic data remains consistent with a slow growth environment but downside risks to the outlook have increased. The US labor market is strong, wages are growing modestly, and inflation remains contained. However, headwinds from trade disputes, slowing global economic growth, an uncertain outlook for Brexit, and geopolitical tensions have increased. The trajectory of economic growth is likely to hinge on the outcome of ongoing trade negotiations as well as policy action by the major global central banks. We believe there is a high level of political pressure to make progress toward a trade agreement with China before the election cycle heats up. We also believe a dovish collective stance by major global central banks should help to combat the headwinds to global economic growth.
The Federal Open Market Committee (FOMC) cut the target fed funds rate by 25 basis points on July 31 to a range of 2.00%-2.25%, as widely expected. The Fed also decided to end their balance sheet normalization program two months early (as of August 1st). There were two dissenting votes from policymakers who preferred to keep the fed funds rate unchanged. Fed Chair Powell indicated that the impetus for the rate cut was threefold; a decline in the neutral fed funds rate, global economic weakness, and the desire to reset inflation expectations. Powell referred to the cut as a “mid-cycle adjustment to policy” and said that he did not believe it was the beginning of a long rate-cutting cycle. We believe Fed Chair Powell left the door open for further monetary policy accommodation but tempered expectations for a series of future rate cuts. We believe another rate cut before year-end is possible, particularly in light of ongoing global trade tensions and an uncertain outlook for Brexit.
Treasury yields were little changed at July month-end. The 3-month T-bill yield was down about three basis points to 2.06%, the 2-year Treasury yield was up 12 basis points to 1.87%, and the 10-year Treasury yield was nearly unchanged at 2.01%. An inversion of the yield curve in which the 10-year Treasury yield is lower than the 3-month T-bill yield is generally viewed as a powerful predictive signal of an upcoming recession. However, we believe increased short-term Treasury issuance to fund the deficit, and negative long-term sovereign bond yields in other countries have distorted the US Treasury yield curve. Sovereign 10-year bond yields around the world have been under pressure and the yields on both the 10-year German Bund and 10- year Japanese Government Bond were negative at July month-end.