Federal Reserve Interest Rate Decision, US Retail Sales and Geopolitical Tensions: Implications and Insights

Waiting for the Federal Reserve's Decision

Market analysts are eagerly anticipating the Federal Reserve's decision to cut interest rates for the first time in years. According to a Bloomberg economist survey, a 25 basis points (bps) cut is expected. However, the market is divided between a 25bps and 50bps cut, leading to the highest speculation in Fed Funds futures since they began trading in 1988. Some are humorously suggesting a 37.5bps cut to satisfy everyone, while others are interpreting "50-50" as a consecutive fifty basis points cut, implying that rates could continue to be slashed as seen in past crashes and recessions. Meanwhile, Democratic senators are advocating for a 75bps cut.

US Retail Sales Data and Industrial Production

It was hoped that US retail sales data would support the case for a 25 or 50bps cut, but the results were mixed. The headline figure was stronger than consensus, but the figure excluding autos was weaker. On the other hand, industrial production surged by 0.8% month-on-month, outperforming the expected 0.2%. However, it would be ironic if this sector, which neither the Fed nor financial markets seem particularly interested in, prevents interest rates from falling as quickly as anticipated. Additionally, the Atlanta Fed's GDP survey currently estimates Q3 growth at 3.0%, significantly higher than the US trend growth of 2%, with only two weeks of data left before the end of the quarter. This raises questions about the connection between this Fed series, the real economy, the FOMC, and the markets. Furthermore, concerns are growing about a potential strike at east coast US ports next month, which could lead to a general softening of freight rates.

Geopolitical Tensions in the Middle East

Meanwhile, the Middle East is teetering on the brink of crisis following an attack that triggered the simultaneous explosion of thousands of pagers held by members of the Iran-backed Lebanese terrorist militia Hezbollah. The Lebanese government and Hezbollah have blamed Israel for the attack, with Hezbollah promising retaliation. The US has denied any involvement, a move that some argue reduces its perceived power and exacerbates geopolitical tensions. Israel has not claimed responsibility for the attack, but it has dealt a severe blow to Hezbollah, which recently switched to low-tech pagers to avoid interception of its communications and GPS locations. The attack has left Hezbollah unable to communicate amidst rumors of a potential Israeli ground incursion.

Weaponisation of Common Devices

The incident raises concerns about the weaponisation of common devices within a supply chain. The US is already attempting to remove Chinese technology like Huawei's 5G due to security concerns, and it is well-known that electric vehicles record all our activities. The question now is how long it will be before more mundane made-in-China consumer products are also deemed too risky. This could lead to further national-security onshoring in the near future.

Implications for the Federal Reserve

This situation could have implications for the Federal Reserve's decision. The deep China supply-chain deflation that is currently making a 50bps move seem feasible may not last long. If this happens, the market could experience significant volatility. Imagine normalising 75bps Fed hikes against rising inflation, then 50bps cuts in a fair economy, only to realise that the decision was wrong and a U-turn is necessary.

European Central Bank's Cautious Approach

Ironically, while the Fed is considering a significant cut despite some positive US data, the European Central Bank (ECB) is playing its hand more cautiously as the German ZEW survey collapses. The Financial Times editorial suggests that ECB President Mario Draghi is trying to save Europe from itself. The new team appointed by EU Commission President Ursula von der Leyen to achieve this includes countries that favour market intervention, such as France, Spain, and Italy, in prime posts like anti-trust, state aid, EU spending, and industrial policy. The outgoing free-market competition commissioner has warned against allowing pan-EU champions to emerge, describing this as a "Pandora's box" for Europe.

Australia's Government and RBA at Odds

In Australia, the government and the Reserve Bank of Australia (RBA) are at loggerheads. A former senior RBA manager has called for reform of the bank's board to avoid groupthink. The RBA is also planning to experiment with a wholesale banking central bank digital currency (CBDC) for the next three years to try to streamline settlement processes. However, there are no plans yet for retail or government use. If a central bank-controlled digital currency that can be printed or deleted at will were to become a reality, it could have explosive implications.

Bottom Line

In conclusion, the market is waiting for the Federal Reserve's decision on interest rates, while also keeping an eye on geopolitical tensions. These developments could have far-reaching implications for the global economy and financial markets. What are your thoughts on this? Feel free to share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.