Making The Case For A June Fed Rate Cut

This week’s Federal Reserve announcement may be one of the most important ones in recent memory given the increased expectation among investors that the Fed will now be cutting interest rates at least once by the end of the year.

The bond market is currently pricing in only a 25.8% chance the Fed will cut interest rates Wednesday afternoon at 2 p.m. ET, but at least one prominent Wall Street economist said Tuesday there’s a strong case to be made for the Fed to go ahead and pull the trigger on a cut this week.

MKM Partners chief economist Michael Darda said Tuesday if the Federal Reserve is going to cut rates at some point, it should go ahead and do it now or it will increase the risk of a sharp downturn in the economy.

“Our argument has been that the longer the Fed waits to cut, the longer certain parts of the yield curve will remain inverted, and the higher the probability that the soft landing scenario slips away,” Darda wrote in a note.

Low Risk Of Hyperinflation

Darda said the risk that a rate cut will trigger hyperinflation seems relatively low given last week’s University of Michigan survey found five to 10-year U.S. inflation expectations are at their lowest levels in history and the bond market is pricing in its lowest inflation rate outlook since 2016.

In addition, given interest rates are currently relatively low compared to prior peaks in the economic cycle, the Fed doesn’t have as much ammo to combat an economic downturn as it has in the past. Rather than wait for a recession to unfold and hope that they can do enough to reverse it, Darda said the Fed should go ahead and do what it can now to prevent the recession from developing in the first place.

Darda said the Fed twice cut interest rates by 0.75% in 1995 and 1998, and both cuts prolonged the growth cycle and helped the U.S. avoid a recession.

“In other words, what the Fed did worked, which is why it looked (later) like it was unnecessary,” Darda said.

Investors Expecting Rate Cut

While investors are skeptical that a rate cut is coming on Wednesday, they are expecting at least one by the end of the year, according to CME Group’s FedWatch tool. The bond market is currently pricing in a 98.1% chance of at least a 0.25% rate cut by the end of 2019 and an 83.6% chance of at least a 0.5% cut this year.

The SPDR S&P 500 ETF Trust SPY traded higher by 1% on Tuesday on trade deal optimism, and is now once again trading near all-time highs.

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