INSIGHT: US Fed moves closer to rate cuts, paving way for chemicals demand recovery

NEW YORK (ICIS)–The US chemical industry, along with other interest-rate sensitive sectors, is poised to get a lift as the US Federal Reserve moves closer towards its first interest rate cut – a move increasingly likely in September.

“The economy is moving closer to the point at which it will be appropriate to reduce our policy rate,” said Fed chair Jerome Powell at the FOMC press conference.

“The question will be whether the totality of the data, the evolving outlook and the balance of risks are consistent with rising confidence on inflation and maintaining a solid labor market. If that test is met, a reduction in our policy rate could be on the table as soon as the next meeting in September,” he added.

The economy is seeing broader disinflation today, including now in both housing and non-housing services, compared to last year when it was centered on goods.

FOCUS SHIFTS TO LABOR MARKET
After being laser-focused on bringing inflation down to its target of 2% for the past couple of years, the Fed is now more confident on progress towards this goal and is thus focusing more evenly on its dual mandate of maximum employment as well as price stability.

“When we were far away from our inflation mandate, we had to focus on that. Now we’re back to closer to an even focus,” said Powell.

“You’re back to [labor] conditions that are close to 2019 conditions, and that was not an inflationary economy… We don’t think of the labor market in its current state as a likely source of significant inflationary pressures,” he added.

Powell said he does not want to see further material cooling in the labor market.

Unemployment has ticked up to 4.1% today versus a low of 3.4% in April 2023. Other measures have also indicated softening, including the Employment Cost Index (ECI) and the Job Openings and Labor Turnover Survey (JOLTS) report.

In the latest JOLTS report, the ratio of job openings to number of unemployed remained at 1.2x, basically back to pre-pandemic levels. The number of hires also ticked down.

CHEMICAL INDUSTRY AWAITS RATE CUTS
A rate cut in September, along with guidance of further cuts to come, would be welcome news for the chemical sector as the long-anticipated H2 2024 recovery is pretty much dead, according to comments on Q2 earnings calls.

Dow chief financial officer Jeff Tate told ICIS he expects weakness in building and construction (B&C) and consumer durables demand to persist through 2024, and that substantial rate cuts are needed to kick start demand.

“In terms of the timing [of a meaningful recovery] going into 2025, from our vantage point, we think it’s going to take some substantive interest rate movement,” said Tate.

“If mortgage rates are in that 7%-plus range, we probably need to start to see that trending towards a 5%-type of handle to really get that sizeable movement – to really release some of that residential housing momentum that is impacting consumer durables,” he added.

Several chemical companies cited ongoing weakness in residential building and construction on their Q2 earnings calls.

High interest rates have hurt affordability for housing, not only dampening sales of new homes, but existing homes as those with low-rate mortgages from purchasing or refinancing during the pandemic are disincentivized to move – locked in their so-called “golden handcuffs”.

The stock market, including chemical stocks, rallied hard into the Fed press conference and maintained their gains through the close. In the past couple of weeks, chemical and other economically sensitive stocks have caught a bid in anticipation of the Fed preparing to ease.

LONG AND VARIABLE LAGS
Just as there are “long and variable lags” to when the economy responds to rate hikes, as we are seeing with the easing of inflation and the labor market today after the Fed finally stopped hiking rates after July 2023, it works the same for rate cuts.

It will take time for the economy to respond favorably to rate cuts as well and thus the risk of recession is not off the table. However, the Fed is confident it is in a good position to deal with unexpected weakness.

“We’re certainly very well positioned to respond to weakness with the policy rate at 5.3%. We certainly have a lot of room to respond if we were to see weakness,” said Powell.

Insight article by Joseph Chang