Fed holds, pound breaks $1.27 ahead of BoE
Stocks firmed and the dollar fell, whilst gold rallied to a 5-year high as the Fed opened the door to cutting rates.
It’s like 2010 all over: the race to the bottom is on. Only this time the global economy is coming off a period of remarkable synchronised expansion, not a terrible recession and the worst financial crisis in a generation or more. So what gives!? Must Powell acquiesce to the whims of his president? Must Draghi end his tenure not normalising, but actually cutting rates even deeper?
Draghi to be fair has little option. In the absence of
structural and fiscal reform – blame Germany – he can but tinker around the edges
of the zero lower bound, hoping to weaken the currency to get some
competitiveness back. Powell is in a different position, although really it
looks like central banks are spitting in the wind in trying to shift inflation
expectations. They should try to focus on boosting oil prices instead.
So yesterday the FOMC nudged towards a cut. Nearly half
the 17 members of the FOMC think cuts will be warranted this year. The median
dot plot suggests 50bps in cuts through 2020. The dots evinced a shift from a
tightening bias to an easing bias. The patient mantra was dropped, whilst the
economy is now only expanding at a ‘moderate’, not ‘solid’, rate. The market
took this as a sign the Fed’s listening to their demands – a cut in July is now
fully priced in.
But there’s yet optionality for Powell and co. The Fed
refrained from explicit references to cuts. The median dot plot shows no cuts
this year still. The market is ahead of itself again. If we believe the dots,
rate cuts will come slower than the market wants them to.
In some ways the Fed thread the needle here – keeping the
market and the president happy without actually committing to cuts. The dots
suggest the Fed is saying: “Of course we will cut, just not yet-good enough?”.
For now it is. But the tail seems to be wagging the dog, forcing the Fed to
follow sooner or later.
Certainly revising inflation expectations lower points to
concerns that tame price growth cannot simply be attributed to transient
factors. Yet at the same time the Fed thinks unemployment will be lower and
growth stronger than it thought in March.
The problem we have is that Fed looks like it is
flip-flopping; changes its mind based not on economic data but on the caprice
of financial markets; appears in thrall to the White House; and is therefore at
a very serious risk of losing its credibility.
Yields hit the deck. US 10yr bond yields slipped beneath
2% again for the first time since 2016. Bunds heading deeper into negative
Gold rallied on the outcome as yields sank, breaking
north of $1385. It’s now cleared a tonne of important multi-year resistance,
paving the way for a return to $1400 and beyond. This is a big move, but if the
Fed doesn’t deliver the cuts the bulls could be caught out.
Stocks liked it – the S&P 500 notched gains of about
0.3%, Limited upside as the Fed was not as dovish as the market wanted and
because a lot of this was already priced in. Asian markets rallied across the
Futures show European stocks are on the front foot,
catching a tailwind from Wall Street and the Fed. The FTSE 100 may underperform
though as the pound is finding bid.
Oil has climbed as US inventories feel three times more
than expected. Brent was up at $63.50, threatening to break free from its
recent range – look for $63.80. WTI at $55.50 also close to breaking out of its
The dollar kicked lower after the Fed decision – but with
the ECB looking super easy the gains versus the euro are limited. Likewise the
yen with the Bank of Japan also ready to step up stimulus. Likewise the
Australian dollar, with RBA governor Lowe talking up a further, imminent, cut.
The race to the bottom is on. Is it too soon to talk about currency wars?
The exception here is the Bank of England, which
is heading towards raising rates. We get to learn more about the BoE’s position
later today. The difference here is the inflation expectations, which are
moving up, not down like they are elsewhere. Britain’s also enjoying strong
wage growth and a super-tight labour market. All of this is dependent on a
smooth Brexit – this is not a given by any means.
Indeed, Brexit is keeping the lid on sterling’s
gains – the prospect of Boris Johnson taking Britain out of the EU come October
31st is a risk. There’s now talk of a possible general election if
he gets in – risky, we know what happened to May. The prospect of a general
election would not do anything to remove uncertainty around UK assets. Zero
EURUSD moved through 1.12 and was last at 1.1280, but
failing to gain enough momentum to rally above 1.13 and scrub out the
GBPUSD has reclaimed 1.27. Quite a chunky move here,
blasting through a couple of big figures in under a day. Maybe the prospect of
a more hawkish BoE is helping the pound, albeit the market is actually pricing
in cuts, not hikes. At least Mark Carney doesn’t have to deal with a political
leader on his case…
USDJPY lost the 108 handle to trade at 107.50, now
breaking free into new 2019 lows (ex the Jan flash crash).”