Are the US and NZ Weighing Prolonged High Rates?

Yesterday (Tuesday, 9 July), Federal Reserve chair Jerome Powell acknowledged that while there has been progress in reducing inflation in the United States, maintaining tight monetary policy for an extended period could negatively affect economic growth. 

Meanwhile, the Reserve Bank of New Zealand (RBNZ) kept interest rates steady at 5.50% today (Thursday, 10 July). Still, it acknowledged that the nation may be experiencing slower growth and reduced activity in recent quarters. 

Does this mean the Fed and the RBNZ are ready to cut interest rates? What should traders expect? What should they monitor? Let’s take a closer look.

Is Powell's Optimism About Inflation Balanced by Concerns Over High Rate Risks?

During the first day of the two-day semiannual hearing before the House Financial Services Committee that takes place on the 9th and 10th of July, Powell noted that the Federal Reserve (Fed) has made considerable progress towards its 2% inflation goal. He also stressed that the FOMC is still hesitant to lower interest rates since there is not enough evidence to support a sustained decline in inflation that would bring it to 2% over the medium term.

The Consumer Price Index (CPI) inflation rate is predicted to decrease to 3.1% in June from 3.3% in May, after peaking at 9.1% in 2022. The data is scheduled for publication tomorrow (Thursday, 11 July). The Personal Consumption Expenditures (PCE) index, the Fed's preferred inflation gauge, decreased to 2.6% in May from 2.7% in April and March. The June data is expected to be released on Friday, 26 July.

However, high inflation is not the only concern. There are also signs of weakening economic activity and employment. This is potentially pushing Fed officials to deliberate on the timing of interest rate cuts, having maintained them at their highest levels in decades for about a year. As the Fed’s borrowing rate is now at its highest level in almost 23 years, in the range of 5.25% to 5.50%, FOMC members are pondering what their next move should be.

"If we loosen policy too late or too little, we could hurt economic activity" Powell stated. "If we loosen policy too much or too soon, then we could undermine the progress on inflation. So we’re very much balancing those two risks, and that’s really the essence of what we’re thinking about these days". 

It will be interesting to see what monetary policy course the Fed will actually take in its upcoming meeting on 30-31 July.

Are Rate Cuts on the Horizon For the Fed?

​​Powell emphasised how important it is to avoid making decisions on "the timing of any future actions" regarding interest rates. This is consistent with the Fed’s current strategy of focusing on new economic data and possible Fed measures in reaction to them rather than offering precise instructions on when and how choices may be made.

While FOMC members' dot plot from their June meeting indicated that they only saw one rate cut in 2024, some market players believe the Fed will begin lowering rates in September and may even decrease them by another quarter point by year's end.

Has Economic Weakening Led to RBNZ's Shift Towards a More Dovish Speech?

Once again, the Reserve Bank of New Zealand (RBNZ) has maintained interest rates at 5.5% for the eighth consecutive meeting. However, it seems that the central bank has adjusted its previous hawkish position, which suggests that there may be a shift towards a less tightened monetary policy. This change could be attributed to the impact of recent data showing a decrease in economic activity. It seems that the RBNZ has acknowledged that its current monetary policy might be affecting domestic demand more than it originally expected. This stance has significantly changed since May’s monetary policy meeting when the RBNZ discussed the possibility of raising rates and did not expect any rate cuts until late 2025.

According to the most recent economic indicators, there are indications of a possible decline in the New Zealand economy for the quarter ending June. The Gross Domestic Product (GDP) has declined for five of the last seven quarters. There is also a downturn in the service and manufacturing sectors, accompanied by a decline in business confidence.

Furthermore, during the first quarter of 2024, there was a 0.2% growth in GDP compared to the previous quarter. This followed a 0.1% contraction in the December 2023 quarter and a 0.3% contraction in the September 2023 quarter. With two consecutive quarters of negative growth, New Zealand has officially entered a technical recession for the second time in just 18 months.

What Could RBNZ's Next Move Be?

The RBZN will meet next on Wednesday, 14 August, coming on the heels of the release of critical economic data, including figures on inflation and the state of the labour market for the second quarter of 2024.  With this fresh information, some economists anticipate a shift in the RBNZ's stance. They expect a more open discussion regarding the possibility of reducing interest rates. This could signal a potential turning point in the RBNZ's monetary policy trajectory and a potential rate cut as early as November 2024. (Source: Yahoo Finance)

Conclusion

The Federal Reserve and the Reserve Bank of New Zealand may be walking on a tightrope. While progress has been made in reducing inflation, they are wary of cutting interest rates too soon and reigniting inflationary pressures. However, signs of slowing economic growth pressure them to ease off. 

Any relevant news and market insights between their meetings are likely to influence their analysis of the current economic situation and their subsequent move regarding interest rates. Traders might want to keep an eye on the economic calendar.