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The Fed’s expected rate cut not supported by economic data

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If the Federal Reserve follows through on strong hints that it will be cutting interest rates in late July, it will do so in the face of a powerful consumer, a record-breaking stock market and an increasingly difficult case to make for easier monetary policy.

Justifying a policy easing against that kind of a backdrop might be tricky for the Fed, even though markets fully expect a cut this month plus perhaps two more before the end of the year. The central bank is not normally in the business of easing into an economy that is showing few signs of a recession, generally holding fire until more pronounced signs of a slowdown are in view.

But this is not a normal time in the world of monetary policy, and the Fed is likely to follow though despite the solid economic signals.

“It just doesn’t smell right given the strength of the economic data,” said Chris Rupkey, chief financial economist at MUFG Union Bank. “The consumer is back in a big way. You really have to ask yourself why they are going to cut rates.”

Indeed, the latest data points to solid consumers, who accounted for 67.4% of economic activity in the first quarter.

Retail sales rose 0.4% in June, according to Commerce Department figures that easily topped the 0.1% expected gain. On a year-over-year basis, sales increased 3.4%.

“This really takes the cake in terms of just how strong the consumer is,” Rupkey said. “The Fed has their story and they’re sticking to it. So despite the data, despite the strong jobs numbers, they believe this is an insurance cut. A risk management cut is necessary for two factors: one is the slowing global economy, and No. 2 is the fact that inflation has been below the 2% target for so long. Given those two factors, I expect them to go. If not, you’re going to hear a whole lot of ruckus out of the White House.”

Fed Chairman Jerome Powell, in a speech Tuesday, outlined a laundry list of factors concerning officials.

Along with the usual suspects — the slowing global economy and the back-and-forth trade battle between the U.S. and China — he also cited debt ceiling negotiations in Congress, a potentially messy Brexit and the Fed’s nagging inability to bring inflation up to the 2% target level it feels is healthy in a growing economy.

Fed speakers pointing to cut

The chairman repeated his intention to “act as appropriate to sustain the expansion,” a phrase seen in the markets as code for an impending rate cut.

His comments were echoed by other officials.

Chicago Fed President Charles Evans, in a CNBC interview Tuesday, cited inflation as his overriding concern that makes him open to “a couple” rate cuts before the end of the year that he said still may not be enough for the central bank to achieve its objectives. Dallas President Robert Kaplan told The Wall Street Journal that falling government bond yields are sending a market signal to the Fed that its funds rate, currently pegged in a range between 2.25% and 2.5%, may be too high.

So while a 25 basis point cut at the end of the month seems baked in the cake at this point, an aggressive easing cycle ahead would run counter to Fed officials’ assessment of an otherwise strong economy led by a resilient consumer.

At the June Federal Open Market Committee policy meeting, members repeatedly cited “solid” prospects for personal consumption expenditures, according to minutes released last week. The key for markets, though, was a passage in the meeting summary that said officials “agreed that risks and uncertainties surrounding the economic outlook had intensified and many judged that additional policy accommodation would be warranted if they continued to weigh on the economic outlook.”

While the market sees sharply lower rates ahead, economists remain divided.

  • Curt Long, chief economist at the National Association of Federally-Insured Credit Unions, said consumers are “resilient,” and while a quarter-point cut seems inevitable, “there is not yet a compelling case for further easing this year.”
  • Citigroup economist Veronica Clark said the most recent spate of economic data indicates “fewer downside risks to the outlook than even just a month ago” making “a modest” quarter-point cut “the most likely scenario.”
  • Andrew Hunter, senior U.S. economist at Capital Economics, remains of the outlook that the Fed ultimately will have to ease aggressively, but thinks expectations for a half-point cut in July “look well wide of the mark.”

Still, the Fed is going to continue to get pressure, both from the markets and from an increasingly impatient White House, where the preference for a weaker dollar is in line with the Fed’s renewed emphasis on sparking inflation expectations.

Joe LaVorgna, chief Americas economist at Natixis, said there’s actually a good case for a half-point cut this month, based solely on the Fed needing to fix an inverted yield curve, meaning that short-term rates are now higher than long-term rates.

The average inversion between the fed funds rate and the 10-year Treasury was 31 basis points in June, meaning “the Fed must do more to rectify the current inversion,” LaVorgna said in a note.

“If the Fed does surprise, it will be in the direction of more easing rather than none,” he added.

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China warns US to stop wrong trade actions or face consequences

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China said on Saturday it strongly opposes Washington’s decision to levy additional tariffs on $550 billion worth of Chinese goods and warned the United States of consequences if it does not end its “wrong actions”.

The comments made by China’s Ministry of Commerce came after the U.S. President Donald Trump announced on Friday that Washington will impose an additional 5% duty the Chinese goods, hours after Beijing announced its latest retaliatory tariffs on about $75 billion worth of U.S. goods, in the latest tit-for-tat moves in their bilateral trade dispute.

“Such unilateral and bullying trade protectionism and maximum pressure violates the consensus reached by head of China and United States, violates the principle of mutual respect and mutual benefit, and seriously damages the multilateral trade system and the normal international trade order,” China’s commerce ministry said in a statement on Saturday.

“China strongly urges the United States not to misjudge the situation or underestimate determination of the Chinese people,” it added.

Trump’s latest tariff move, announced on Twitter, said the United States would raise its existing tariffs on $250 billion worth of Chinese imports to 30% from the current 25% beginning on Oct. 1, the 70th anniversary of the founding of the communist People’s Republic of China.

At the same time, Trump announced an increase in planned tariffs on the remaining $300 billion worth of Chinese goods to 15% from 10%. The United States will begin imposing those tariffs on some products starting Sept. 1, but tariffs on about half of those goods have been delayed until Dec. 15.

Trump was responding to Beijing’s decision on Friday night that it was planning to impose retaliatory tariff on $75 billion worth of U.S. imports ranging from soybean to ethanol. China will also reinstitute tariffs of 25% on cars and 5% on auto parts suspended last December.

The White House economic adviser said earlier in the week the Trump administration was planning in-person talks between U.S. and Chinese officials in September. It is unclear if the bilateral meeting would still take place.

The year-long trade war between the world’s two largest economies has roiled financial markets and shaken the global economy.

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Protesters march near Biarritz demanding action from G-7 leaders

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French activist Jean-Baptiste Redde, aka Voltuan (R) holds a placard reading ‘stop climate crime’ next to a demonstrator dressed as a traditional Basque shepherd, during a march in Hendaye, south-west France on August 24, 2019, to protest against the annual G7 Summit attended by the leaders of the world’s seven richest democracies, Britain, Canada, France, Germany, Italy, Japan and the United States.

GEORGES GOBET | AFP | Getty Images

Thousands of anti-globalisation and environmental activists joined yellow vest protesters and Basque separatists on Saturday near the French coastal resort of Biarritz to demand action from G7 and other world leaders set to meet there.

Protesters converged on the nearby town of Hendaye on the French border with Spain to protest against economic and climate policies pursued by the world’s leading industrial nations and to promote alternatives.

“The top capitalist leaders are here and we have to show them that the fight continues,” said Alain Missana, 48, an electrician wearing a yellow vest — symbol of the anti-government demonstrations that have been held in France for months.

“It’s more money for the rich and nothing for the poor. We see the Amazonian forests burning and the arctic melting. The leaders will hear us,” he said.

Fires are devastating large swathes of the forest which is considered a vital bulwark against climate change.

Protesters waved banners for causes ranging from gay rights to Palestine, but their messages were aimed firmly at the leaders of the United States, Germany, France, Britain, Canada, Japan and Italy who are set to begin three days of talks on Saturday.

“No to the G7. For another world,” one banner read. “Heads of state the Amazon is burning. Act now,” said another.

The protesters marched under bright-blue summer skies from Hendaye to the town of Irun, Spain, some 30 km (18 miles) south of the G7 venue Biarritz.

More than 13,000 police officers, backed by soldiers, are guarding the Biarritz summit site and police had feared that anarchist groups might have tried to derail Saturday’s protest, which has been billed as a peaceful, family event.

Four police officers were lightly wounded on Friday after protesters fired a homemade mortar near the anti-G7 counter summit in Hendaye. Police arrested 17 people for hiding their faces.

There was no immediate sign of any radical groups on Saturday and the police presence was light.

Protesters came from all parts of France and beyond including from across the border, where Basque separatists were also keen to show their solidarity.

“The counter-G7 demonstration is in this Basque region and we want people to see we are part of it,” said Alfredo Akuna, a 46-year-old engineer from San Sebastián who wore traditional Basque clothing.

“We’re involved in many movements including anti-capitalism and anti-fascism so it’s important to be here to show that.”

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EU will retaliate if US imposes tariffs on France over digital tax

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The European Union will “respond in kind” if the U.S. imposes tariffs on France over digital tax plan, Donald Tusk, president of the European Council said on Saturday.

Speaking at the G-7 leaders meet in Biarritz in France, Tusk said if President Donald Trump uses tariffs for political reasons then it can be risk for the whole world, including the EU, Reuters reported. 

Earlier on Saturday, Trump criticized the French digital tax aimed at big U.S. technology companies and threatened again to retaliate by taxing French wine.

Speaking to reporters at the White House before leaving for a Group of Seven summit in France, Trump said he is not a “big fan” of tech companies but “those are great American companies and frankly I don’t want France going out and taxing our companies.”

“And if they do that … we’ll be taxing their wine like they’ve never seen before,” he said according to Reuters.

France passed a 3% tax in July that targets roughly 30 big tech companies including Facebook, Amazon and Google. The levy applies to companies with more than 750 million euros ($830 million) in annual revenues from “digital activities,” including 25 million euros ($27 million) from within France.

Reuters contributed to this report.

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