When the going gets tough, the cuts keep coming

​​​​​Today's news headlines:

  • ‘Parties' spending plans signal the return of "1970s-sized state"’. The UK’s two main political parties are pledging to increase spending ahead of the December election signalling a reversal in recent UK austerity measures. According to research, the spending plans could increase the size of the state to 1970s levels. (Financial Times)
  • ‘Ross optimistic on China deal, Trump wants it signed in US’. The US Commerce Secretary is optimistic that the ‘phase one’ trade deal between the US and China will be signed this month, adding US companies will be granted licences to sell components to Huawei Technologies 'very shortly'. Trump wants the deal to be signed in the US following the cancellation of the Asia-Pacific Economic Cooperation summit in Chile last month. (Bloomberg)

Where now for the Fed?

It’s been a challenging year for Jerome Powell at the Federal Reserve. The head of the US central bank has been locked in a tug of war with markets since December 2018 when, safe to say, they disagreed with his decision to raise interest rates to 2.5%. Following the announcement, both the stock and bond markets plummeted, emphasised by the S&P 500’s fall of over 20% by Christmas from its most recent peak. This reaction was due to thinking that the Fed had become overly restrictive in its policy, at a time when trade headwinds were likely to drive the global economy toward a recession. By June 2019, the US yield curve had inverted, meaning that short-term government debt would pay investors more than the longer-term equivalent—a sign that the worst was yet to come.

Fast forward to today, and we seem to have escaped from the brink—albeit with some kicking and screaming from Powell along the way. The Fed has caved, reducing the upper bound of interest rates from 2.5% to 1.75% in three consecutive meetings, but has pledged to pause the 'mid-cycle adjustment' in December. Recent core data, including Gross Domestic Product growth and Non-Farm Payrolls, may just about support that stance. Still, the rate decision could end up being closer than the mere 11% chance of a cut currently predicted by the Fed Funds Futures market. Friday’s ISM Manufacturing Purchasing Managers' Index data came in below expectations, remaining in contractionary territory for the third straight month. A continued theme of negative data throughout the coming month could result in renewed pressures for further cuts.

Bottom line: It’s important to note that pure 'mid-cycle adjustments' don’t happen all that often. Generally, when the Fed starts cutting rates, it does so for a while, as monetary policy tends to move in long cycles. In the last four decades, there have only been two successful 'adjustments' (each totalling 75 basis points) without a recession. The Fed will certainly be wary of this fact going into December’s meeting.

GBP/USD

Cable opened in London above the 1.29 level as the trade-weighted US Dollar Index trades near ten-week lows. December’s UK general election means the Pound could be stuck in a rut as Brexit developments are on pause. Still, the Dollar’s descent below key daily moving averages could keep the pair elevated in the short-run.

GBP/EUR

The pair has stayed around the 1.16 level in recent sessions trading no more than 35 ticks either way for two weeks. The weaker Dollar has helped lift both components of the currency cross, creating low volatility conditions for the pair.

EUR/USD

The pair fell in the London open, trading around the 1.1150 level following stagnant overnight trading near October’s high of 1.1179. A weak US Dollar compounded by better-than-expected European manufacturing data is likely to keep the pair afloat today, possibly testing the 1.1179 resistance level once again.