Recent trade optimism sparked a rebound in stocks, but Deutsche Bank warned if there's an escalation in the trade war, the U.S. could see a "mild recession" and interest rates falling to zero.
The bank said it now predicts cuts will take down the Federal Reserve's key rate - which now ranges between 2% and 2.25% - by a full point over the next six months.
"We anticipate 25 [basis] point rate cuts at each of the September, October, December, and January policy meetings," David Folkerts-Landau, group chief economist, said in a note to clients on Tuesday.
Folkerts-Landau also said he expects economic growth to fall to below 1.5% by mid-2020, assuming the trade tensions between the U.S. and China ease or maintain the status quo.
"If the conflict picks up, the U.S. risks zero rates and a mild recession," Folkerts-Landau. "Some de-escalation recently on U.S.-China trade front, but no signs of a deal as yet."
China said Wednesday it plans to exempt 16 types of U.S. products from additional tariffs, including food for livestock and cancer drugs. The move came as high-level trade officials from China and the U.S. are set to meet in Washington next month. China also reportedly offered to increase purchases of U.S. agricultural products. The Dow Jones Industrial Average gained about 700 points over the past week amid the optimism of a trade deal.
The Federal Reserve cut interest rates for the first time in more than a decade in July, citing trade uncertainties and muted inflation. The central bank is widely expected to cut another quarter point when the Federal Open Market Committee holds its two-day meeting starting Sept. 17.
"In the U.S., our economists have revised down their growth forecasts, largely as a result of trade uncertainty," Folkerts-Landau said. "Manufacturing is contracting and there are cracks in the otherwise strong labor market."
The U.S. manufacturing contracted for the first time in three years last month. While the overall labor market is still in good shape with the unemployment rate at 3.7%, private-sector employment grew at the lowest pace since February.
"There is also an ever-present risk of rates falling back to the lower bound − This argues for more pre-emptive easing," Folkerts-Landau said.