As late as last December, Goldman was expecting four rate hikes in 2019. Then, as recently as mid-June, the “smartest men in the Goldman room”, did not expect the Fed to cut rates at all in July and September. Of course, all that changed when it became clear that “Powell has thrown in the towel”, and will follow the demands of the president and the whims of the market, resulting in the first “mid-cycle” rate cut last month in over a decade.

As a result, Goldman’s “base case is now that no deal will be reached before the 2020 election. We expect the newly announced 10% tariffs on the last $300bn to remain in place on Election Day, and other forms of tit-for-tat retaliation are possible along the way.”

In parallel with this extended trade war, the bank has extended its prior forecast of two rate cuts in 2019, and now expects two back-to-back rate cuts from the Fed: “In light of growing trade policy risks, market expectations for much deeper rate cuts, and an increase in global risk related to the possibility of a no-deal Brexit, we now expect a third 25bp rate cut in October, for a total of 75bp of cuts.

Goldman explains that “the balance of risks has shifted enough to make a third 25bp rate cut in October the most likely outcome, for a total of 75bp of cuts including the July cut.” Specifically, for the September meeting, Goldman sees a 75% chance of a 25bp cut, a 15% chance of a 50bp cut, and a 10% chance of no cut. For the October meeting we see a 50% chance of a 25bp cut, a 10% chance of a 50bp cut, and a 40% chance of no cut.

This is contrary to the message the Fed was trying to convey, as Mericle thinks “the FOMC most likely envisioned at its July meeting that rate cuts would eventually total 50bp. This strikes us as the best guess of what Chair Powell meant by a “mid-cycle adjustment” to “adjust policy to a somewhat more accommodative stance over time,” as well as the most likely compromise on a divided committee in which many participants were skeptical of the case for cutting at all.”

So picking up where Goldman left off last week when it tried to infer what it would take for the Fed to stop cutting rates, the bank now says that “for rate cuts to stop, Fed officials will eventually have to withstand White House demands and perhaps bond market expectations as well” and it adds that by the December meeting “the FOMC is likely to stop.”

Source: Goldman Sachs and Zerohedge