FrontierView recently launched The Lens, a weekly newsletter published by our Global Economics and Scenarios team to highlight developments and trends that will have the highest impact on business scenarios. Below is an excerpt from this week’s edition highlighting Federal Reserve policy changes and supply chain disruption in the Persian Gulf.
Fed eases policy, marking end of a 4-year tightening cycle
- The Federal Reserve (Fed) cut its benchmark interest rates by 0.25% on Wednesday, in line with consensus.
- The Fed also announced that it would stop selling assets, which it gradually began to do in February 2015, from its balance sheet. This signals the beginning of the tightening cycle.
- The Fed statement noted that, while labor markets and household spending remained solid, a rate cut was justified by weak business investment and inflation that remained below its 2% target.
- US Q2 GDP came in at 2.1%, a significant deceleration in growth from 3.1% in Q1. However, the underlying data in Q2 is actually much stronger than in Q1. Consumer spending, around 70% of US GDP, accelerated to 4.3% in Q2 after growing at a very slow rate of 1.1% in Q1.
- Investment growth in Q2 was very weak, contracting by 5.5%, the worst quarterly investment growth since Q4 2015. This weakness corresponds with the renewed trade tensions with China that began in late April.
The Fed remains worried that the US economy may slow primarily due to weak external growth or an increase in restrictive trade measures, either of which could tip the economy into an investment-led growth contraction. The Fed also does not want to disappoint financial markets–which had fully priced in at least one Fed cut at this meeting–because financial market volatility can also lead to a pullback in business investment and consumer spending. Until the next Fed meeting in mid-September, economic data responding to this rate cut will be closely monitored, and the Fed will prepare to ease rates again if needed.
The second quarter GDP print confirms our US outlook. The US economy is expected to decelerate in 2019 and 2020, driven by lower investment, but consumer spending is expected to continue to show strong growth and provide opportunities for premiumization. This Fed cut simply adds additional some additional support to the economy by somewhat easing financial conditions, but most importantly, by signalling that the Fed will respond to any weakness in the data with additional monetary stimulus.
Supply chain disruption risks rise in the Persian Gulf
- Tensions in the Persian Gulf rise even as talks between Iran, India, and the UK continue over seized tankers. In mid-July, Iran seized a Panamanian flagged tanker claiming it was smuggling Iranian oil and a British tanker in response to the UK’s seizure of a tanker carrying Iranian oil.
- Military presence in the Gulf is increasing due to these events. The UK has deployed a second warship and the US has sent additional aircraft to patrol the Strait of Hormuz. The US is also sending more than 500 troops, defense missiles, and fighter aircraft to Saudi Arabia.
- Despite building tensions, all parties are pushing for a diplomatic solution. The UK, France, Germany, Russia, and China met in Vienna to discuss how to save the nuclear deal, while new US Secretary of Defense, Mark Esper, highlighted the US’ willingness to return to the negotiating table. Iran’s foreign minister offered to accelerate the parliamentary ratification of an agreement with the International Atomic Energy Agency about the latter’s access to its nuclear sites and information, in exchange for the easing of US sanctions.
While the EU, Russia, and China pursue diplomatic efforts to save the nuclear deal, Iran will continue to demand deescalation and a return to the 2015 accord. Considering the upcoming US elections, all parties are likely to come back to the negotiating table within the next year. Although all parties want to avoid a direct conflict, rising tensions and a growing military presence are increasing the risk of unintended escalation towards more direct military confrontation.
Oil prices will likely remain stable due to oversupply in the global market unless direct military confrontation or an Iranian blockage of the Strait of Hormuz occurs. These scenarios both carry a low likelihood. However, supply chain disruptions through the Gulf, as well as potential volatility in demand from customers due to stockpiling, should be closely monitored.