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New round of China tariffs could set stage for more Fed rate cuts

8/1/2019 Reuters:  Ann Saphir and Richard Leong

President Donald Trump’s decision to impose new tariffs on Chinese imports has once more thrown the Federal Reserve a curve ball that could prompt the central bank again cut interest rates again to protect the U.S. economy from trade-policy risks.

In a series of tweets Thursday, Trump said he will slap 10% tariffs on $300 billion of Chinese imports starting Sept. 1.

Trump announced a first tranche of duties, of 25% on $200 billion of Chinese goods, in May. The tariffs are aimed at putting pressure on the world’s second biggest economy to strike a trade deal.

The drag those tariffs and other Trump trade policies have had on business sentiment and investment was a key driver of the Fed’s decision this week to cut interest rates for the first time since the financial crisis.

Fed Chairman Jerome Powell said he viewed the cut as an insurance policy against the effects of trade uncertainty, weak global growth and low inflation, calling it a “mid-cycle adjustment” and not a start to a lengthy rate-cutting cycle.

If trade troubles deepen into a full blown trade war, DRW Holdings analyst Lou Brien said, “Any further Fed rate cuts will no longer be considered mid-course adjustments so much as they will be thought of as necessities to prevent a recession.”

Traders are betting the new tariffs make a longer rate-cutting cycle more likely.

U.S. interest rate futures rallied as traders piled on bets that the central bank will cut rates two more times by year’s end and reduce them further next year to offset risks from the escalating trade war.

Fed funds futures implied traders now see a 70% chance the Fed would lower rates again in September, up from 51% late on Wednesday, CME Group’s FedWatch tool showed.

The fed funds complex suggested traders are rebuilding bets on a possible third rate cut by year-end with an implied 60% chance for such a move, up from 39% late Wednesday.

“The key word is ‘uncertainty,” said Richard Bernstein, chief executive at Richard Bernstein Advisors in New York. “Uncertainty acts like the Fed tightening. It raises risk premiums and stymies activity. Full stop.”

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