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Sterling shrugs off central bank scenarios, as markets reassess Fed rate path

It would seem by last night’s market reaction that Fed chairman Jay Powell has come a long way from his October comments that the Fed was a “long way from neutral”, and which some have argued helped trigger the recent bout of stock market volatility.

His comments that rates were now close to the neutral level helped pull the Dow to its biggest one day gain since March and pushed treasury yields sharply lower with the 10 year yield hitting its lowest level since mid-September.

It is true that his comments appear to be softer than his August comments but are they that much different, given that he still said that rates weren’t quite there yet, and were just below the “range of estimates of the level that would be neutral”.

The fact is each Fed member has a different assessment of where “neutral” is, which might suggest that Chairman Powell was trying to insert slightly more ambiguity into market expectations of what the Fed might do next year. A December rate rise still seems the most likely outcome, however expectations about the pace for rates next year has become much more ambiguous, which helps give the Fed much more wriggle room.

Given this week’s comments from various Fed policymakers you would have to surmise that tonight’s Fed minutes are likely to be fairly stale and not particularly reflective of current thinking, though it will be interesting if the change of tone that we heard this week, is reflected in some of the discussions.

Asia markets were slightly more mixed with the Nikkei225 following US markets higher, while Chinese markets declined, as investors there focussed on the upcoming G20 summit at the weekend.

The tailwind from last night’s US session has blown through modestly to markets in Europe this morning.

The pound appears to have shrugged off the furore over last night’s Bank of England’s Brexit scenarios or forecasts, however you choose to describe them, with the main focus being on the disorderly scenario of an 8% drop in GDP, a rise in interest rates to 5.5% and drop in the pound below parity against the US dollar.

It is not hard to see how these could be viewed through any other lens, than some form of forecast, simply because of the political nature of how they would likely be perceived.

Is it really credible to suggest that the Bank would seriously raise rates to 5.5% in the event of a “no deal” scenario when in the wake of the referendum result they did the opposite, after warning of an immediate and sudden slowdown in economic activity? The warning of a further 25% depreciation in the value of the pound also seem a little steep given that some of the negativity may well already be priced in.

These longer term projections also appear to take no account of any fiscal levers any future government might pull to mitigate any negative effects, and assume that the EU wouldn’t take any measures to offset any ripple out effect into their economy. These projections would not be a zero sum game and any disorderly Brexit would surely prompt measures from the other side of the Channel to soften any negative over spill. Given the central banks rather patchy record of predicting GDP in more normal environments it rather suspends belief that they can predict or assess with any degree of confidence what might happen one year from now let alone ten years from now.

As far as the bank stress tests are concerned all of the banks passed fairly comfortably in the most extreme scenarios though Lloyds was perceived to be the most vulnerable due to its high UK exposure of credit card loans and mortgages. The banking sector has moved slightly higher in early trade this morning with Lloyds and RBS amongst the better performers, though HSBC is lagging behind.

Unilever is also in the news again today after yesterday’s reports about its interest in Glaxo’s Horlicks unit in India surfaced. It is now being reported that CEO Paul Polman is to retire, to be replaced by Alan Jope who currently holds the position of being the head of the Personal Care division. This move while surprising in its timing, probably shouldn’t be too unexpected given the botched attempt to move its primary listing to Amsterdam, which upset a lot of UK based shareholders. It also brings to a close a ten year tenure in charge of what has been a profitable period for the company, but it also allows senior management to renew the relationship with their major shareholders which was damaged by the listing row.

The commercial real estate sector has come under pressure on the back of this morning’s news that Brookfield Property Group which owns office buildings in New York, London and Los Angeles dropped its bid for Intu Properties whose assets include shopping centres Lakeside in Thurrock, the Trafford Centre in Manchester and the Metro Centre in Gateshead.

Intu shares have plunged with the company also reducing the dividend, while cutting the value of its properties by 9%. Sector peers Hammerson and Land Securities have also come under pressure.

After last night’s big US surge its likely to be a more sober open for today as traders reparse Powell’s comments and set themselves up tonight’s Fed minutes.

In earnings news US retail remains in focus with Abercrombie and Fitch set to post its latest Q3 numbers. The company has had a disappointing year despite evidence that same store sales of its own branded and Hollister branded garments showed a pickup in Q2. While the company made a surprise profit in its second quarter revenues were disappointing at $847m. Profits in Q3 are expected to come in at $0.208c a share.

On the data front the latest core PCE numbers, and the Fed’s preferred inflationary measure is set to show a slight fall in October to 1.9% from 2%.  

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