Don’t fight the Fed

​​​​​​Today's news headlines:

  • ‘Hammond warns Tories on Brexit impasse’ Chancellor Philip Hammond is speaking today to re-emphasise the dangers of no-deal Brexit and urge MPs to obtain a larger mandate from the electorate by considering a general election or second referendum. (Financial Times)
  • ‘Johnson’s clear-cut vision begins to blur as policies face scrutiny’ It is ironic that Boris Johnsons plans come under closer scrutiny – and reveal yawning gaps – just as he is consolidating his lead in the race for number 10.  (Financial Times)

Powell strikes the right tone

The worst kept secret in global markets is out, as Jerome Powell and his colleagues opened the door to an interest rate cut as early as next month. The language was dovish as Powell made clear that uncertainty over the Trump’s trade battles and weaker inflation forecasting were factors behind the shift.

Goldman Sachs Analysts now expect the Federal Reserve to cut interest rates in both July and September.  However, Powell refused to rule out the possibility of a single 50bps cut, commenting that “It will depend very heavily on incoming data and the evolving risk picture as we move forward”. Expectations that the US central bank will soon be cutting rates has driven treasury yields lower and boosted gold to the highest level since 2013.

Last night’s meeting was important for the Fed’s credibility, demonstrating their willingness to listen to the messages being sent by markets by striking the right tone. Seven policymakers updated their forecasts to the ‘Cut Camp’, leaving the Fed almost evenly split on the direction of rates later this year. What is clear is that they remain resistant to the idea of insurance cuts, preferring to “act as appropriate” on the data.

Bottom Line: The case is strengthening for a cycle of easing, yet the overall message received from the Fed and Powell yesterday was to wait a little to learn a lot. The stressing of data dependency in the press conference will have markets closely watching the array of economic data released before the next FOMC meeting in July. Bond markets don’t really seem to care as they bet heavily on a July cut.

And all the rest...

The Feds FOMC meeting was undoubtedly last night’s main event, but certainly not the only game in town.  We heard from several central banks and central bankers which are contributing to the more upbeat tone in markets this morning.

  • The Bank of Japan stood steady on rates but highlighted external risk to growth.
  • This morning the European Central Bank’s (ECB) Oli Rehn highlighted a ‘softer patch’ and said all policy instruments are at the ready.
  • Also, this morning, ‘ECB’s Guindos: Euro Area Inflation to deteriorate’ (Bloomberg)
  • Overnight, the Reserve Bank of Australia’s Governor, Philip Lowe, reiterated a potential for further interest rate cuts. The cut on 4th June was the first RBA loosening of policy in three years.

With so many central bankers espousing a negative economic outlook, the resulting risk-on move may seem counterintuitive.  What it really symbolises is a collective sigh of relief, that rising prices and untenable market levels may continue or even extend yet less supportable levels.  This is nothing to cheer about, since risk assets have less and less to do with underlying economic growth than it once did. 

Bottom line: This latest tilt toward supportive central bank action is aimed at preventing a sharp potential economic decline if a slowdown were to become more acute.  It doesn’t change the current downward path of economic growth.  Rather than focusing on asset prices, turn your attention to leading economic indicators – like PMI survey data – and default rates in credit markets which are forecast to increase.

GBP/USD

Last night’s dovish Fed Press Conference resulted in strong boost to risk sentiment, causing a sharp pull back in USD and rally in the Pound.  Sterling is likely to remain limited to the upside in advance of the Bank of England meeting this afternoon where the MPC has fewer and fewer reasons to consider a rate hike and a lengthening period of political uncertainty.

GBP/EUR

The new-found risk on stance has also benefited the common currency which had been faltering the last few sessions. The Sterling rally marginally exceeded the EUR move so on the pair we’ve seen a small tick higher. The ECB has also been polishing their policy tools in anticipation of deployment, which has contributed to the confident push higher on equities.

EUR/USD

Yesterday the 50-day moving average was providing only minimal support against a further downward push, but today it’s a strikingly different tone. The pair has risen above the 100-day moving average and kept on going.