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Updated 14:34 20/10/19

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Federal Reserve votes for first interest rate cut for a decade


Liam Sheasby

Liam Sheasby, News Editor
1 Aug 2019, 2:37 p.m.

The US Federal Reserve has announced it plans to cut interest rates by 0.25%, bringing the new benchmark to between 2% and 2.25%.

Committee members voted 8-2 in favour of cutting rates at a meeting yesterday evening, with Eric Rosengren (Boston Fed president) and Esther George (Kansas City Fed president) voting against the decision.

The move is designed to support the US economy – which has been performing better than most nations – as growth begins to slow in the face of trade tariffs and protectionism across the globe. One key indicator that should be concerning the Fed, however, is the negative yield rate currently visible. This is normally an indicator of a looming recession, and while the US economy on the face of it is in a solid position, things can change quickly and dramatically in an economy.

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A return to rate cutting?

The cut will be the first in a decade, when the Fed was reacting to the impact of the financial crisis in October 2008. Rates were cut by 0.5% then, dropping from 2% to 1.5%. The Fed then cut again in December 2008, sinking rates to as low was 0.25% to encourage lending and the movement of capital around the US economy.

Interest rate rises resumed in 2015 and have steadily continued since, with the last rise coming at Christmas last year. President Trump opposed the rise, and the latest cut is effectively the Federal Reserve undoing that decision.

Trump has been a major critic of the Federal Reserve and the Fed’s chairman Jerome Powell in particular, with repeated claims that Powell is pursuing the wrong monetary policy. Other economists criticised the Fed for sounding too upbeat in their market commentary, suggesting they may be underestimating the economic slowdown and the conditions present.

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Powell’s response:

Speaking to the press yesterday, Jerome Powell told reporters: “When you think about rate-cutting cycles, they go on for a long time and the committee’s not seeing that. Not seeing us in that place. You would do that if you saw real economic weakness and you thought that the federal funds rate needed to be cut a lot. That’s not what we’re seeing.

Powell’s statement went on to say that the Fed was making steady changes “in light of the implications of global developments for the economic outlook as well as muted inflation pressures”. There are rumours that the next rate cut will be in September – another quarter percent – though there will likely be continued resistance internally.

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Interest Rates & Gold:

The impact on gold from a rate cut is usually two-fold: firstly, lower interest rates mean lower yields, which make other assets less attractive. As gold does not offer any yield, this effectively evens the playing field up for bullion as an asset and decreases the opportunity cost in holding gold. Secondly, rate cuts show a lack of confidence in the wider economy and suggests weakness. Gold does well in times of economic uncertainty as a hedge against risk, so demand should theoretically improve.

Gold has gained almost $123 per ounce in the past three months – even accounting for the $24.31 lost in the past 24 hours as investors gauge the markets. Demand has been strong in the face of global risks such as the US/China trade war, conflict in the Gulf, widespread rate cutting in the Eurozone, and Brexit here in the UK.

The good news for gold buyers is that August (historically) is a strong month for gold. Typically, prices rally in August, and 13 of the last 15 Augusts have experienced price rises for the precious metal.

So far, the price of gold has fallen slightly, down to $1,406.05 per ounce from $1,430. Analysts aren’t too worried, with the Dollar strengthening against the basket of major global currencies. The expectation is that the immediate response will be investors re-balancing their portfolios and taking account of what the changes actually mean. This is already taking place in Asia, where stock markets hit a six-week low. There is also the expectation of renewed tensions between the US and China, the US and Iran, and potentially the US and North Korea following their latest missile tests.

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What next?

The likelihood is that President Trump will continue to rail against Chairman Powell for the foreseeable future, unless the Fed cuts rates further this year. While many will be unhappy with the President’s interference in what is supposed to be an independent organisation and policy-making, the Fed aren’t helping themselves by having to backtrack on previous decisions.

The next rate cut is rumoured to be another 0.25% in September, with some even suggesting that the Federal Reserve might go for three more cuts this year if necessary. Given the opposition to this cut though, and the Fed’s preference for quantitative tightening rather than easing, such a change in stance seems unlikely unless the US economy begins to show rapid signs of stagnation.

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