With U.S. stimulus fading, Fed can’t ignore stagnant global growth, Morgan Stanley argues

(MarketWatch) As the Federal Reserve gets set to cut interest rates, one question that keeps popping up is why the central bank feels a need to act, given the underpinning of a strong domestic jobs market.

Morgan Stanley, in a new research note, traced the Fed’s repeated references to the global economy, which it said started in a January 2015 statement from the Federal Open Market Committee referencing international developments. That clause about international developments has remained in every statement since.

The brokerage then lists six other examples, including Federal Reserve Chairman Jerome Powell’s comments on Tuesday in Paris, where he said that, “since the crisis, policy makers are even more keenly aware of the relevance of global factors to our policies. The global nature of the financial crisis and the channels through which it spread sharply highlight the interconnectedness of our economic, financial and policy environments. U.S.economic developments affect the rest of the world, and the reverse is also true.”

Morgan Stanley pointed to a reason for the Fed’s greater overseas interest. International trade’s share of U.S. GDP has shot upward to nearly 30% last year, up from 18% in 1980, and financial linkages have also skyrocketed. Overseas corporate income as a share of GDP has nearly doubled to over 20% from about 10% in 1980.

There have been three times when shocks from outside the U.S. have hit home — the late 1990s, encompassing the Mexican peso crisis, the Asian financial crisis and the collapse of Long-Term Capital Management; the 2011-13 European recession; and the 2015-16 Chinese slowdown. The Morgan Stanley note points out the Fed has responded on all three occasions.

With the stimulus from the late 2017 tax cuts fading, the direct impact of the global economy has shown up in slowing U.S. growth.

“This downdraft and trade tensions are now dampening U.S. growth, especially in the more internationally exposed segments of trade and manufacturing, while weighing on corporate sentiment and business investment as well,” the analysts say.

International developments, they point out, are not encouraging. There’s what they call an “uncertain pause” between the U.S. and China on trade talks, lingering tensions between the U.S. and Mexico and the European Union, as well as the possibility of a French technology tax, and Japan–South Korea trade tensions. “This suggests to us that corporate confidence is likely to stay muted and the risks to the global outlook are still skewed to the downside,” they note.

In the U.S., the slowing momentum could bring corporate credit risks to the fore, especially as corporate leverage has picked among by riskier borrowers.

The research note argued for a “strong policy response,” though it didn’t say whether it anticipated the Federal Reserve would cut target interest rates by a quarter- or a half-point at the end of the month.

Fed funds futures as derived by CME’s FedWatch tool show a 100% market expectation of a rate cut, with 32% expecting a half-point and 68% expecting a quarter-point.

Stock futures pointed to opening gains for the Dow Jones Industrial Average on Wednesday after a mild drop on Tuesday. The yield on the 10-year Treasury, down 56 basis points for the year, was 2.10%.


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