With a July cut almost assured, how far will the Fed go?

As anticipation grows for a Fed rate cut this month, many are still wondering whether action is necessary, CIBC Capital Markets chief economist Avery Shenfeld writes in a report released Thursday.

After all, positive U.S. economic data, from jobs growth to a rise in core inflation, would usually indicate there’s no need for such a move.

But Shenfeld says a cut on July 31 is “a done deal,” viewing the move as an insurance policy based on a risk-versus-reward calculation: the cost of not cutting rates if it turns out such action was needed is higher than the costs of having to undo a rate cut that the economy didn’t need.

A slight drop in hours worked in the second quarter and the downward trend in residential construction are potential signs of a recession ahead, which could be enough for a quarter-point cut later this month and another before the end of the year, Shenfeld writes.

Given the early action, 50 basis points of total cuts will suffice, he says. That’s less than the extended cuts into 2020 that the bond market is pricing in.

“Our call is that this year’s rate relief, and perhaps some progress on trade talks in the first half of 2020, should obviate the need for additional Fed cuts next year,” Shenfeld says. “If so, equities will get some comfort from signs that the expansion has more room to run, but Treasuries investors will give back some of the past year’s winnings.”

Shenfeld notes that the biggest growth concern is the potential hit from a trade escalation, which “can’t of course be seen in the data today.” A report from the C.D. Howe Institute addresses the issue of uncertainty for central bankers.

The commentary from former senior deputy Bank of Canada governor Paul Jenkins urges central bankers to distinguish between risk and uncertainty. While policy decisions require a judgment about the economic outlook that balances risks, issues such as Brexit, U.S.-China trade tensions and climate change present a degree of uncertainty that makes a single judgment “nearly impossible.”

In these situations, there isn’t enough information to calculate probabilities and base a policy on them. Rather than ignoring the uncertainties, Jenkins writes that it’s better to acknowledge them as part of a modelling and communications strategy.

“In such a situation, it is far better for the central bank to be up front about the extent of uncertainty, share a narrative that acknowledges these uncertainties and relays a story to assist economic agents to understand what they are confronting,” the report says.

Read the full C.D. Howe commentary here and the CIBC economic insights report here.

Mark Burgess

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Mark was the managing editor of Advisor.ca from 2017 to 2024.