The US Consumer sentiment Index rose above market expectations to 92 during the month of September and the outlook for consumption still points at positive growth. Given the strong labour market and unemployment rates at historical lows, consumers still have reasons to be positive. In fact, household spending has played a significant role in supporting the United States economic expansion.

Meanwhile, business confidence and capital expenditure plans are weighed down on the back of uncertainty surrounding trade policy and concerns about global growth. Related measures including capital expenditures, Purchasing Manager Indices and export orders have continued to weaken, pointing at a deceleration in economic activity in the manufacturing sector.

The US ISM Manufacturing PMI fell from 51.2 to 49.1 in August 2019, missing market expectations of 51.1. This also pointed to the first month of contraction in the manufacturing sector since January 2016.

As trade tensions are expected to remain a headwind for economic outlook, business sentiment is likely to be suppressed. These conflicting sentiment factors have not gone unnoticed by the US Federal Reserve (Fed).

During the Federal Open Market Committee meeting on Wednesday, Fed Chairman Jerome Powell announced the second interest rate cut in a decade. The Fed lowered the fed funds target rate by another 0.25% to the range of 1.75% to 2.0%.

This monetary stimulus had been widely priced in by investors since the start of August. Going forward, the Fed’s projections signalled a more hawkish stance than the market expected, with the median forecast indicating that rates would remain at the same level up to 2020.

This week also marked the Fed’s first intervention in more than a decade in the overnight money market due to pressures related to the shortage of funds in the banking system. As liquidity dried up, the interest rates in US money markets, known as the overnight repurchase rate shot up and exceeded the federal-funds rate. Given that the federal funds rate is the benchmark for all borrowing costs in the financial system, the Fed was forced to intervene to push the rate down within the target and to ensure that banks have enough liquidity to meet operational needs and maintain reserves.

Impact of oil prices on the Fed

The spike in oil prices occurred ahead of the FOMC meeting on Wednesday. A supply disruption in the oil market was caused by drone attacks on two Saudi Arabian oil facilities last Saturday. Following reassurance that production could be restored by the end of September, the threat to global supply has diminished. However, the risk of further retaliation in the Middle East remains.

Although US inflation continues to linger below the 2% goal, impact of sustained higher oil prices on the Fed’s decision is likely to be limiting since the Fed’s preferred measure of inflation is the Core Personal Consumption Expenditure Index.

This measure excludes changes in consumer food and energy prices and thus would not reflect the volatility in the oil market. However, if the oil price remains elevated, it could be viewed as a tax on households and non-oil business. In other words, higher oil prices could lead to declines in business and consumer expenditure which in turn impacts GDP growth. This could support the case for further monetary easing.

This article was issued by Rachel Meilak, Equity Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.