The US Fed held rates steady in December and plans to continue that stance through 2020. But a lot can happen to change the Fed’s mind—after all, it entered 2019 expecting to hike rates and ended up with three cuts. What does 2020 have in store?
The outlook is unusually cloudy. Geopolitical events like the US-China trade war could reignite, and the looming US elections, with every House seat, 35 Senate seats and the presidency on the ballot, could leave the US economy and financial markets on volatile ground.
Given the substantial amount of uncertainty, we don’t think it’s practical to put a single forecast on the Fed’s policy actions for 2020. We think a better approach is to establish a range of scenarios and what the Fed might do in each case. As the year progresses, we can better evaluate which path the US economy is on and update expectations accordingly.
As we see it, there are three main paths that could influence the Fed’s next moves (Display).
Path One: The Clouds Lift and Growth Picks Up
The recent Phase One US-China trade agreement could prompt businesses to reboot investment spending, a major culprit behind the late-2019 economic slowdown. If investment picks up, consumer spending should remain strong and the economy could top its 2.0% growth potential in 2020. Strong growth and strong labor markets could heat up inflation, leading to rate hikes.
We agree that the economic outlook has become somewhat brighter lately, but we still think inflation will remain subdued. Even if it does perk up, we think the Fed will see this as a desirable outcome, and will still be very slow to raise interest rates. For that reason, we have a relatively low probability on this scenario. Probability: 10%.