By Shrutee Sarkar
BENGALURU (Reuters) - The chances of a Federal Reserve interest rate cut this year have dramatically increased in the past month, according to a Reuters poll of economists who warned trade tensions will intensify and the risk of a U.S. recession has crept up.
Fed Chair Jerome Powell said last week the central bank would act "as appropriate" to address risks from the U.S.-China trade war, leaving the door open for a possible rate cut. That is the second sudden shift in the Fed's tone after it changed its policy bias away from steady tightening in January.
While many economists now argue the Fed is likely to cut rates this year, some said they were reluctant to change their base case forecasts for the federal funds rate immediately, citing rapidly changing developments on trade talks.
The consensus in the June 7-12 poll of over 100 economists showed the Fed will hold interest rates steady at 2.25-2.50% this year and not cut rates until the third quarter next year - taking the fed funds rate to 2.00-2.25%.
While the latest consensus points to rates on hold this year, 40 of 100 common contributors from last month forecast at least one rate cut at some point in 2019, compared to just eight respondents in the previous poll.
When asked about the probability of one Fed rate cut this year, the median from a smaller sample of economists showed a 55% chance, with the highest at 100%. The probability was a still-high 40% for two rate cuts this year.
"There is a full-blown trade war. This final round of tariffs against China is the big, big concern," said Scott Brown, chief economist at Raymond James.
"I think there is certainly scope for them to cut rates. If not in June, July is still a strong possibility. But obviously...that it is going to depend on the economic data. If we start to see some strong numbers, it would push that out."
Interest rate futures markets are already pricing in an 80% chance of a rate cut by July. The dollar is set to maintain its strength for the rest of this year but will come under pressure from the trade war and eventual Fed rate cuts.
The sharp escalation in the U.S.-China trade conflict and U.S. President Donald Trump's surprise threat of tariffs on Mexico in May fueled recession fears. That has made for the most turbulent month so far this year for stock markets.
While Wall Street has snapped back on optimism over Trump's decision on Friday to hold off import tariffs on Mexico, over two-thirds of economists who answered an additional question said tensions between the United States and its trading partners would intensify this year.
"Trump is in an ebullient mood, talking up the resilience of the U.S. economy and its ability to withstand any negative fallout from trade tensions," said James Knightley, chief international economist at ING.
"Yet markets aren't convinced. Bond yields are plumbing to new lows, equities have dipped and two Fed rate cuts are now priced in for the next 12 months."
Trump is due to meet Chinese President Xi Jinping at the June 28-29 G20 summit of world leaders in Osaka, Japan.
A PASSING STORM
Indeed, some economists are still clinging to the view this is only a passing storm, and the Fed will resume raising rates next year. Those say they are reluctant to chop their already-modest growth and inflation forecasts.
The growth outlook remained largely unchanged from last month's poll. The Fed's preferred measure of inflation, which has remained below the central bank's target so far this year, was not expected to show any significant pick-up anytime soon, either.
"What we worry about with the point forecasts is not necessarily the outlook for growth, it is the downside risks to growth and the uncertainty – it could be a lot weaker," said Raymond James' Brown. "Again, a lot of it hinges on what Trump does with those tariffs."
With trade tensions expected to intensify this year, the chance of a recession in the next 12 months increased to 30% from 25% the previous month. The chance of a slump in the next two years held at 40%.
More than three-quarters of economists gave a higher probability of a recession or at best kept their views unchanged from last month.
"The probability of a recession has risen," said Philip Marey, senior U.S. strategist at Rabobank, one of five institutions in the poll which indicated two consecutive quarters of economic contraction at some point in their forecasts.
"An insurance cut in 2019 by the Fed will not be enough. We expect the U.S. economy to fall into recession in the second half of 2020. This will force the Fed to start a full-blown cutting cycle in 2020."
(Reuters poll graphic on U.S. recession probability: https://tmsnrt.rs/2O50W4M?eikon=true).
(Additional reporting by Manjul Paul; Polling by Nagamani Lingappa and Richa Rebello; Editing by Ross Finley and Andrea Ricci)