Closing on all-time highs, FOMC preview

Morning Note

Equity markets buoyant after Tuesday’s rally ahead of the key Federal Reserve meeting.

You can just about smell the all-time highs. The S&P 500 rallied 28 points to 2,917.75, just a shade under 1% below its April record high. The Dow added 350+ points to 26,465.54. 

And yet the latest BAML data shows fund managers are at their most bearish since the global financial crisis a decade ago. Equity allocations have experienced their second worst drop on record – we’ve seen a huge move into cash. And yet and yet, we’re close to all-time highs again for US equity markets at least. This is what you may call an unloved rally. 

Asian shares were encouraged by Wall Street’s gains. Japan closed 1.72% higher. Futures indicate European shares are treading water ahead of the FOMC decision later today. A touch of caution after an exuberant session yesterday. 

Oil rallied again – demand outlook matters a lot more than supply constraints. The world is awash with oil whatever OPEC does. Brent was close to its $62.50 comfort, the 50% Fib level that continues to anchor prices. WTI has regained $54. On both charts signs of either double-bottom reversal or bearish flag continuation patterns. 

The prospect of president Trump meeting his counterpart Xi Jinping at the G20 assembly later this month, combined with signs of renewed stimulus efforts by the ECB, has investors eyeing short-term gains. We need to wait and see what the Federal Reserve does. So hold on tight, let the flight begin. 

FOMC Preview 

Summary 

You got to know when to hold ‘em, know when to fold ‘em. Markets expect the Fed to cut 3 times this year, but the Fed needs to be careful about reacting too easily to markets. There is not the need to be as pessimistic about growth and inflation as bond markets suggest, despite some softness in recent labour market data. The Fed will seek to avoid sounding overly hawkish, but one feels there is a need to steer markets away from expecting the Fed to ride to the rescue of financial markets.  

Backdrop 

It’s hard to recall a time we headed into an FOMC meeting with so much at stake and with so much uncertainty about what might be agreed and what the guidance for the rest of the year will look like. This means the potential volatility around the event is likely to be substantially higher than at most recent FOMC meetings. 

Macroeconomic indicators suggest slowing growth whilst there have been no positive developments on trade. Inflation is tame but there is arguably enough to keep the Fed on the side lines for the rest of the year. And quite how much the data has softened since the last meeting to suddenly warrant a cut is beyond me. 

Moreover, last week’s retail sales data has gone against the downbeat, pro-cut grain. The Atlanta Fed GDPNow model predicts 2.1% GDP growth in Q2, up from the previous 1.4%. The model now anticipates second-quarter real personal consumption expenditures growth of 3.2% to 3.9%. 

Talk of demoting Jay Powell further clouds the picture as Trump heaps pressure on the  Fed chair to cut. Know when to walk away, know when to run. 

Market pricing 

Markets do not currently anticipate the Fed will cut rates this week, but they are pricing in a cut in July and a subsequent 1-2 25bps cuts.  

Pricing for a rate cut this week dropped sharply – from nearly 30% to around 21% – after the strong retail sales print on Friday. It’s since crept back up to 26%. For July, though, market pricing indicates an 87% chance of a cut, whilst there is a 95% chance for September. 

The blackout period ahead of the meeting has tied tongues that were in overdrive in the preceding days. 

Powell’s comments in Chicago at the start of June were the trigger for a relief rally in equities. He noted ‘recent developments involving trade negotiations and other matters’, adding that: ‘We do not know how or when these issues will be resolved’. 

This was the key remark: ‘We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion’. 

Critically he did not signal a cut, but only stuck to the Fed’s oft-stated stance. Markets have read much more into this, and could be left disappointed. The problem for Powell now is to gently steer markets back to the right course. 

Coming Up Today (GMT) 

GBP- CPI y/y (08:30) 

CAD- CPI m/m (12:30) 

EUR- ECB President Draghi Speaks (14:00) 

USD- FOMC Economic Projections (18:00) 

USD- FOMC Statement (18:00) 

USD- Federal Fund Rate (18:00) 

USD- FOMC Press Conference (18:30) 

BRL -Interest Rate Decision (21:00) 

NZD- GDP q/q (22:45) 

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