Although much of the economic data emerging from the US may make it hard to justify cutting rates, it is likely a rate cut will happen later this year in order to prevent a debt crisis, according to Guy Miller, head of macroeconomics and chief market strategist at Zurich.
Miller says the present low unemployment rate in the US, combined with strong GDP growth and inflation above the Federal Reserve’s 2 per cent target “are conditions not normally associated with rate cuts”.
But he says the markets need “reassurance” because during the period when rates in the US were very low, many companies were able to borrow cheaply, but those businesses will need to refinance that debt in the coming years.
Miller says the market would be concerned about the prospects for those businesses if they have to borrow at much higher rates, and as a result the market will ascribe a much lower valuation to the equity of those businesses.
It is with this in mind that Miller says at least one rate cut will happen this year in the US, and notes if it does not happen, "then the markets will be vulnerable".
One rate cut this year, which is what markets are presently pricing in, would represent a significant reduction relative to the six rate cuts that were priced in last November, a scenario that led to a strong rally in bond and equity markets.
Miller says a feature of economies and markets in the coming years will be a divergence between the paths of the eurozone and the UK, with the relatively weak economic performance of those areas making it more intuitive to cut rates.
A challenge faced by policymakers, and already reflected in the recent weak performance of sterling, is that the UK or eurozone cutting rates before the US does would cause the currencies of those countries to be weak relative to the dollar – something that is itself inflationary as it increases the cost of imported commodities such as oil and basic metals, as those are priced in dollars wherever in the world they are extracted.
Despite that concern, he says he expects the eurozone will “need to cut rates over the summer”, with the Bank of England following shortly afterwards.
Stephen Blitz, chief US economist at GlobalData TS Lombard, says the strong US dollar also has negative consequences for that economy as it makes exports of industrial goods more expensive at a time when a central plank of President Joe Biden’s economic agenda is the 'reshoring' of industrial production.
If the goods are exported from the US, rather than from a cheaper manufacturing site abroad, then the cost base and selling price is in dollars, making it more expensive to export.
Björn Jesch, global chief investment officer at DWS, expects the dollar to remain strong due to the higher yields offered by US government bonds attracting external capital, almost regardless of what happens with rates from here.
