Stock markets surged yesterday after the ECB signalled the prospect of a rate cut as soon as September sending German bund yields to new record lows, and helping US markets back to within touching distance of their record highs of earlier this year. The news that President’s Trump and China’s President Xi will meet for an extended meeting at next week’s G20 also helped give markets a boost, sending markets in Europe back close to their highest levels this year.
This time last year the European Central Bank was telling anyone who would listen that rates would “remain at their present levels at least through the summer of 2019” with the implication being that they could well start to go higher.
While some investors seemed happy to take those comments at face value at the time, the fact that the bank was also downgrading its inflation and growth forecasts, seemed rather at odds with that guidance, inviting some scepticism in some quarters as to whether the guidance was even credible.
We know the answer to that now after ECB President Draghi’s comments in Sintra yesterday, when he suggested that the next move in the rate cycle was likely to be a 10bps cut at the September meeting, in conjunction with the start of the new TLTRO program.
In monetary policy parlance it was the ECB equivalent of throwing in the towel and admitting that there was little chance of them hitting their inflation target any time in the near future, and as for the prospect of future rate rises, not going to happen.
It didn’t take long for Mr Draghi’s comments to attract the ire of President Trump who tweeted that it was unfair to the US, as it weakened the euro. Of course, the President conveniently overlooks the fact that the US Federal Reserve did exactly what he is criticising the ECB for when their actions sent the US dollar sharply lower in 2009, when they started on their massive bond buying program.
Of course, all of this merely increases the pressure on the US Federal Reserve and chairman Powell, who has been on the receiving end of an onslaught of criticism from not only President Trump, but also other White House officials about the level of US interest rates.
This pressure prompted reports that officials in the White House had explored the possibility of demoting the Fed chairman and potentially replacing him with someone more malleable. Putting to one side the enormous damage such an action would have on the reputation of the US for governance, as well as the Fed’s independence, it rather overlooks the fact that rate decisions are agreed by consensus, which means he might potentially have to replace the entire FOMC to get his way. Good luck with that, as they say on social media.
As a result, today’s Fed meeting will be all the more important in how Fed officials spin the narrative on how they see the path for US interest rates over the rest of 2019. Let’s not forget that at end of last year, there was still an expectation that we might see another 3 rate rises this year, so the pendulum has swung all the way back, and then some more, in the space of 7 months.
With President Trump also announcing that he is set to have an extended meeting with President Xi next week at the G20, with respect to trade, any reason that the Fed might have for thinking about a rate cut may well disappeared given that currently US data isn’t showing any significant signs of economic distress.
This will be a problem for a Federal Reserve which has insisted it is very much data dependant, and won’t want to be seen as too dovish lest it be accused of pandering to Trump, while at the same time coming across as too hawkish and pushing the US dollar even higher. The Fed’s biggest problem is the bond market with 10-year yields hitting their lowest levels since September 2017 yesterday.
Markets need to be careful what they wish for in terms of rate expectations. If the Fed is too dovish and signals a July rate cut investors would be justified in thinking further out to when the next cut might be coming, and why the Fed think it necessary to cut now given that the data is still fairly decent, and they are still running down the balance sheet, and this isn’t due to finish until the end of September. Cutting in July while continuing to reduce the size of the balance sheet would make little sense.
How Fed officials deal with this particular issue could dictate whether a July cut is coming. If they maintain the balance sheet runoff into September, then it makes little sense in cutting in July. If on the other hand they decide to terminate it early, that might clear the way for a cut in July or September. As is usual guidance will be key in terms of growth and inflation forecasts as well as the dot plot projections.
On the sterling front the pound rebounded modestly against the euro yesterday but remains under pressure, as it becomes clear that Boris Johnson may well become the next Prime Minister with markets nervous that a “no deal” Brexit might become more likely. Putting to one side that in the absence of MPs agreeing on an alternative that remains the default position it’s not immediately clear why markets are more worried now than a few weeks ago.
On the data front we’ll be getting the latest CPI inflation readings for May this morning. We did see a modest uptick in April largely as a result of increases in energy prices and council tax rates pushing headline CPI up to 2.1% and a six-month high. Core prices were slightly more subdued but nonetheless the weaker pound and higher energy prices do appear to be exerting upward pressure on prices. We could see a rise to 2.2% in May, which will inevitably fuel speculation about a possible interest rate rise. This is highly unlikely to happen any time soon, and while we may get some hawkish noises from tomorrows Bank of England rate decision, there is unlikely to be a consensus for raising rates any time soon.
EURUSD – has slipped below the 1.1200 area, and could well slip further towards the May lows down near 1.1110. We need to see a rebound back above the 1.1270 area to stabilise and retarget the 200-day MA at 1. 1370.
GBPUSD – slid below the 1.2550 area, opening up the potential for move towards the low this year at 1.2430. The 1.2760/70 area remains the primary resistance level, and the main obstacle to further gains.
EURGBP – having broken above the 0.8930 area the euro pushed up to the 0.8975 area, before retreating. Last years highs at 0.9020 remains a key resistance area. Having rallied for 7 weeks in a row, we’re on course for week 8 while above the 0.8900 level. While above the 0.8870 area, we could still see a retest of 0.9000.
USDJPY – still toppy anywhere near the 108.80 area, but still have support down near the 107.70/80 area. We need to push back through the 108.80 area to retarget a move to the 109.20/30 area. Bias remains to the downside and the 106.00 area, while below the 109.20 area.
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