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A Third Rate Cut Hinges on Interim Trade Deal: Likely Gainers

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After refraining from reducing benchmark interest rate for nearly eleven years, the Federal Reserve opted for 50 basis points cut in interest rate in two tranches in a span of less than two months this year.

Yet, it failed to generate enthusiasm among market participants, who had a muted response to Fed’s decision. The reason is that, both times, Fed failed to provide a clear indication of a follow up rate cut, likely to come within next 2-3 months.

Fed Chair Jerome Powell has always maintained that the central bank will do whatever necessary to sustain U.S. economic expansion and accordingly take decision for further rate cut.

At present, lingering trade disputes between the United States and China is the primary source of global economic disturbance irrespective of any geopolitical conflict or oil shock. Consequently, possibility of a third rate cut this year depends on the reality of a U.S.-China interim trade deal.

A Divided Fed Cuts Rate Again

On Sep 18, after its two-day FOMC meeting, the Fed decided to reduce the benchmark lending rate by 25 basis points to the range of 1.75-2%, in line with market expectations. Notably, this was the second rate cut this year after one of similar magnitude on Jul 31.

However, the Fed failed to arrive at a unanimous decision. Notably, five members were strongly against a second rate cut, while five members approved the second cut but stated that interest rate should stay there for the rest of the year. Meanwhile, seven Fed members want a third or may be a fourth reduction of benchmark interest rate this year.

The central bank again highlighted the same reasons for the recent rate cut as the first time. A relatively stable U.S. economy is suffering due to global economic slowdown. The trade dispute and muted inflation are the two factors cited for the consecutive rate cut. While strong consumer spending is driving the economy, business fixed investment and exports are suffering due to tariff war.

Trade Dispute is the Major Concern

Neither the United States nor China has appeared victorious in the trade battle so far. Instead both countries along with the global economy have been suffering over the past year owing to slowing growth and exports.

Imposition of tariff on low-cost Chinese intermediary products raised prices of final high-tech products of U.S. companies. Higher input costs, shrinkage in exports and lack of proper government policies resulted in a plunge in business investments.

Moreover, the majority of new tariffs, proposed by the Trump administration, will be implemented on consumer goods. This may significantly affect consumer spending, the largest component of the U.S. GDP. Additionally, U.S. agricultural business is also suffering due to higher Chinese tariff.

The situation in China is even worse. In the second quarter of 2019, China’s economic growth fell to the lowest level in 27 years. Industrial production in August grew at the slowest pace since February 2002. Retail sales in August and investment in fixed asset in the first eight months of 2019 fell below consensus estimates.

China’s imports have fallen in six out of the first seven months this year, indicating sluggish economic growth. Lower Chinese imports are strongly affecting several Eurozone and emerging market economies.  

Fed’s Future Course of Action Depends on Interim Trade Deal

On Sep 12, President Donald Trump told reporters that he is not averse to an interim trade deal with China although his preference will be to have a full agreement resulting in a complete trade deal with the Asian economic powerhouse.

Bloomberg reported that the U.S. government would like to delay the imposition of new tariffs on Chinese goods or it may even roll back some tariffs that are already levied on China for the first time since the trade dispute started in March 2018.

In return, the U.S. government wants China to substantially increase imports of domestic agricultural products. Also, more importantly, China must comply with their earlier commitments related to the use and application of intellectual properties, before the trade negotiation broke down in May.

After a rough August, when the year-old trade conflict between the United States and China heightened, it seems that tensions are now cooling on both sides. Several initiatives have been taken by the economic giants this month to restart the negotiation process.

Although no one is thinking of an immediate solution to the trade dispute, these developments should help in defusing growing trade-induced economic slowdown and stock market volatility.

As a result, Fed’s decision of a third rate cut this year depends largely on how the prolonged trade spat between the two largest trading countries of the world takes shape in the next two to three months.

Likely Gainers of a Third Rate Cut

A third rate cut would happen if the Fed thinks that the economy is not out of the woods at least the external concerns. Consequently, defensive stocks of rate-sensitive sectors like real estate investment trust, utility, telecom and health care will gain the most.

AquaVenture Holdings Ltd. (WAAS - Free Report) , MDU Resources Group Inc. (MDU - Free Report) , Safehold Inc. (SAFE - Free Report) and Chemed Corp. (CHE - Free Report) are some of the stocks from these sectors, currently sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows price performance of above-mentioned stocks in the past three months.


Likely Gainers if Fed Keeps Rate Unchanged

An interim trade deal with China is likely to boost the U.S. economy further, which is still growing, marking the longest expansion in its history. Consequently, cyclical growth stocks will gain. Bank stocks will also gain due to higher yield on government bonds.

Keysight Technologies Inc. (KEYS - Free Report) , Materion Corp. (MTRN - Free Report) , Clean Harbors Inc. (CLH - Free Report) and Crocs Inc. (CROX - Free Report) are some of the stocks in this category, currently sporting a Zacks Rank #1.

The chart below shows price performance of above-mentioned stocks in the past three months.

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