Amid the wave of central bank rate cuts, the Federal Reserve's moves are attracting worldwide attention. In June, the Federal Reserve left its federal funds rate target range unchanged at 2.25%–2.5%. Markets widely expect a rate cut in July, potentially reaching 50 basis points.
Another view, however, is that despite political pressure for greater stimulus, the US central bank has opted for a cautious approach to monetary easing and is preparing to cut rates by 25 basis points.
Although I believe the signs point to a Federal Reserve rate cut being highly likely, I am less optimistic about the size of that cut.
First, expectations of this rate cut are not based on factors such as “a severe US recession, the outbreak of a financial crisis or a marked increase in risk, or overseas market turbulence creating strong expectations of US dollar appreciation” [1]. Rather, the Federal Reserve's dovish turn reflects its assessment of the global macroeconomic outlook, US economic performance, pressure from the Trump administration and other factors.
Second, although the US economy remains relatively strong, uncertainty surrounding US–China trade and the broader global slowdown have increased instability in US financial markets and weakened investment, adversely affecting the US economy to some extent.
For these reasons, I believe the Federal Reserve will make a formal decision only after comprehensively assessing US economic performance in the second or third quarter.
If the US economy performs relatively well in the second and third quarters, a rate cut could be delayed. On 10 July 2019, Federal Reserve Chair Powell's testimony to the House of Representatives on the semi-annual monetary policy report was released.
Powell said the Federal Reserve would act as appropriate to sustain economic growth. This was seen as signalling that it might announce a rate cut at its July meeting. [2]
The scale of the rate cut will not usher in broad-based easing
Expectations of this rate cut do not stem from domestic pressures arising from a severe US economic downturn.
Although the US economy is showing signs of slowing, its overall performance remains relatively strong across the board. Powell said the two main concerns weighing on it were uncertainty over trade tensions and the broader global economic slowdown.
I therefore believe the expected rate cut will be modest. If US economic performance in the second and third quarters is relatively good, the cut could also be delayed. The anticipated cut may not usher in full-scale quantitative easing.
However, as the global economy slows further, central banks will adjust the scale of their rate cuts in response to global macroeconomic conditions. The world could enter an easing environment within a relatively foreseeable timeframe.
The World Bank's June 2019 report states: “Global economic growth is expected to slow to a weaker-than-expected 2.6% in 2019, before edging up to 2.7% in 2020.
Growth in emerging market and developing economies is expected to stabilise next year as some countries move beyond periods of financial strain, but momentum remains weak…
With exports and investment declining, growth across advanced economies as a whole is expected to slow in 2019, particularly in the euro area. US growth is forecast to ease to 2.5% this year, then slow further to 1.7% in 2020.
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Euro area growth is expected to hover around 1.4% from 2020 to 2021. Despite continued monetary policy support, weak trade and domestic demand are weighing on growth.
Growth in emerging market and developing economies is expected to fall to a four-year low of 4% in 2019, before recovering to 4.6% in 2020. Some economies are dealing with the effects of financial stress and political uncertainty.
The global trade growth forecast for 2019 is the weakest since the financial crisis a decade ago. These pressures are expected to ease gradually thereafter, allowing global trade growth to recover.”
Will rate cuts push asset prices higher?
Once a rate-cutting cycle begins, it will substantially boost market expectations. In the United States, major assets such as equities, government bonds and gold could all benefit to some degree. Historical data and experience also show that after the past 5 US rate-hiking cycles ended, capital markets, notably equities and property, experienced varying degrees of prosperity and expansion.
On 10 July, after Powell's monetary policy testimony was released, spot gold jumped US$12 to US$1400. The US dollar index fell, Treasury bonds recovered lost ground, and the ten-year yield stood at 2.063%. Dow futures pared their losses, while S&P 500 futures and Nasdaq index futures rose across the board.
However, monetary policy takes time to reach the real economy, and its transmission effects must also be considered. Monetary policy generally reaches the real economy through channels such as credit and interest rates.
The credit channel mainly involves central banks adjusting commercial banks' reserve requirements to change their lending capacity, while the interest rate channel mainly involves adjusting short-term lending rates. Put more simply, this concerns whether people can borrow more from banks, what interest rates they pay, how demanding personal or business credit requirements are, and whether lending conditions are relaxed.
The effectiveness of interest rate and credit transmission therefore depends heavily on government financial policy. Without fully supportive financial policy, monetary policy alone will not necessarily transmit into a sharp rise in asset prices.
How will New Zealand's housing market be affected?
As is widely known, New Zealand was among the earlier countries to announce a rate cut in 2019. This was mainly due to sluggish economic growth and weak investment. Markets widely expect another rate cut in New Zealand this year.
A Federal Reserve rate cut could also affect the funding costs of New Zealand banks and financial institutions through its transmission channels. This could lower financing costs in the real economy, bolster market confidence and support economic growth.
However, given global financial and economic uncertainty and the current tense and complex international situation, an unexpected crisis could offset the benefits of a global easing environment driven by expectations of a Federal Reserve rate cut.
The future direction of New Zealand's housing market still depends largely on continued favourable government policies, including financial, immigration and trade policies, and expectations of a stable international political and economic environment. However, with the 2020 general election approaching, electoral uncertainty could interrupt the effective transmission of rate cuts.
Overall, I believe New Zealand's property market, particularly Auckland's property market and asset prices, could benefit from rate-cut stimulus and financial policies between 2019 and 2020, bringing a modest short-term recovery. Some favourable policies could even provide a strong short-term boost to the housing market and asset prices.
However, the election could prompt a period of waiting and watching in the second half of 2020, making a sharp rise in asset prices difficult. If market conditions remain favourable across the board and there is no major upheaval in the global economy or financial system, the genuine market recovery people are hoping for could arrive at the end of 2020 or later.
Note: the views expressed in this article are the author's own and do not constitute investment advice.
[1] Source: Rushi Institute of Finance
[2] Source: Wallstreetcn
About the author:
Frank Chen
CEO of Singapore's Ansheng Group
Director of New Zealand Ansheng Property Development Limited (APG)