The US Federal Reserve’s decisions on interest rates can have large and wide-ranging impacts on stock markets, bond markets and currencies all over the world, including Australia.

Latest economic research from CBA’s Global Market Research team highlights that the team now expect the US Federal Reserve to start a rate cut cycle in December 2019.

With central banks typically lowering interest rates to stimulate economic growth, CBA Senior Currency Strategist Joseph Capurso said: “The expected rate cuts in the United States are ‘insurance’ against recession risks.”

When interest rates are lowered, consumer and business borrowing and then spending typically increase after a lag, eventually driving higher wages and prices.

“The US Federal Reserve has the luxury of entertaining rate cuts because inflation is low,” Mr Capurso said. In a typical US recession, the funds rate is cut by more than 6 per cent. “Given the starting point of 2.25 to 2.50 per cent, we predict the US federal interest rate cut will be relatively modest at 1 per cent,” Mr Capurso said.

There are two benefits of starting an ‘insurance’ rate cut cycle early. First, a recession is more likely to be avoided. Second, the size of the rate cut cycle can be smaller than usual. The longer the Federal Reserve waits the greater the interest rate cuts will need to be later.

“As the largest economy in the world, a stronger US economy is in everybody’s interest, including Australia, because it means larger demand for commodities and more tourist arrivals.”

CBA economists change Australian dollar forecasts

CBA economists also recently made modest cuts to their near-term Australian dollar forecasts. “At the end of September we predict the Aussie dollar will be 68 cents compared to 72 cents previously,” said Mr Capurso.

“Our new forecasts take into account our forecast for rate cuts by the Reserve Bank and the Federal Reserve. The reason we don’t forecast a lower Australian dollar is because of high commodity prices, interest rate cuts by the Federal Reserve and looser financial policy by APRA,” he added.