The decision by the Federal Reserve to unexpectedly cut interest rates by 0.5% yesterday was meant to inject confidence into the markets but it had the opposite effect.
Typically a reduction in interest rates assists stocks, but yesterday the Fed’s plan backfired. When central banks loosen monetary policy their intention is to encourage economic activity through borrowing for investment, and well as the consumption of goods and services by individuals, but traders were questioning the potential impact of yesterday’s rate cut on the economy.
The coronavirus crisis has brought about lockdowns. It has disrupted supply chains as well as caused people to curtail their travel plans. Dealers rightly asked the question, what good will the sizeable interest rate cut actually achieve. The move is unlikely to spur on business investment or jolt consumers into spending more. If individuals are worried about lockdowns, the lower interest rate will hardly bring about an uptick in economic activity.
The decision by the Fed was misguided from an image point of view as it gave off the impression they are extremely worried about the coronavirus situation, and that’s why US stocks fell as traders picked up on that nervousness. Cutting rates is a rushed fashion projects the wrong image. From the practical point of view, it was an unwise decision too, as US interest rates have halved since last summer, so should the US economy get seriously impacted by the health crisis, the central bank will have less room to manoeuvre in terms of cutting rates.
The rate cut injected volatility into the markets, but when it was all said and done, the FTSE 100, DAX plus the CAC 40 closed in around their respective lows of the session. The European indices all registered gains yesterday as they opened higher and gained ground in the morning, but when stocks move lower post a big rate cut, it’s not a good look.
The Dow Jones, S&P 500 as well as the NASDAQ 100 ended the session firmly in the red as dealers became more worried about the state of the US economy after the Fed’s move. Jerome Powell, the Fed chief, talked about the strength of the US economy in his press conference after the rate decision, which begged the question, why cuts at all. The central banker claimed that politics didn’t come into the equation, but some dealers have their suspicions.
Overnight the Caixin survey of Chinese services was 26.5, which was a big fall from 51.8 in the previous update. It was the worst reading on record. Despite the sharp declines suffered in the US, the equity markets in Asia are mixed. The Chinese central bank kept short-term interest rates on hold.
US index futures are higher as there are early indications that Joe Biden did well on ‘Super Tuesday’. Mr Biden is fairly centrist as far as Democrats go, and traders would be less worried him potentially going head-to-head with President Trump as he is more pro-business than Bernie Sanders.
S&P Global Ratings lowered their outlook for the US economy. The group previously predicted the US economy would grow at 2.2% in the first three months, while now they feel it would be closer to 1%. The group also feel it would grow by closer to 1% in the second-quarter.
AUD/USD is higher as Australian GDP in the final quarter was 0.5%, topping forecasts marginally.
Oil saw a big swing yesterday as the energy was driving higher on speculation that OPEC will lower production in a bid to stabilise the oil market. The Fed news had a negative impact on the oil market as traders because worried about the health of the US economy. The Joint Technical Committee recommended that OPEC+ cut output by 600,000-1 million barrels per day – the news added to oil’s downfall as a big cut, suggests a big fall in demand. At 3.30pm (UK time) the EIA oil inventory report will be published and oil stockpiles are expected to increase by 3.5 million barrels, while gasoline stockpiles are tipped to fall by 1.87 million barrels.
The US dollar index fell to a level last seen in mid-January in the wake of the cut, and keep in mind, in late February it hit its highest level since 2017. GBP/USD gained ground yesterday, but to be fair to the pound, it was already in demand on the back of the robust UK construction PMI data, which jumped to 52.6 from 48.8 in January.
Gold was lifted by the weaker dollar, but the flight to quality strategy helped too as dealers dropped US stocks. The US 10-year yield fell below 1% for the first time as the exodus from equities saw funds pour into government bonds.
The eurozone posted mixed inflation data. Headline flash CPI cooled to 1.2% from 1.4%, while the core reading ticked up to 1.2% from 1.1%. The core figure is typically seen as a more accurate reading of demand, so the slight nudge higher is a step in the right direction for the bloc.
Yesterday the G7 finance ministers held a conference call to discuss how to tackle the coronavirus, and in the end it was a non-event. The group essentially said they are observing the situation and they will be ready to act should they feel it is necessary – within a few hours the Fed cut rates.
The Bank of Canada will announce their interest rate decision at 3pm (UK time). Traders are pricing in a very high chance of a 0.25% interest rate cut to 1.5%. In light of the Fed, the BoC might go down the 0.5% cut route too.
German retail sales will be posted at 7am (UK time) and the monthly reading is tipped to be 1%, which could be a big rebound from the 3.3% fall in the previous update. Eurozone retails sales are due out at 10am (UK time), the reading is expected to be 0.6% on a monthly basis.
Between 8.15am (UK time) and 9.30am (UK time) Spain, Italy, France, Germany and the UK will publish their final readings of the latest services PMI reports, and the consensus estimates are 52.5, 51.4,52.6,53.3 and 53.3 respectively.
The final reading of fourth-quarter GDP from Italy is expected to be -0.3%, unchanged from the initial reading. It will be announced at 9am (UK time).
At 1.15pm (UK time) the ADP employment report will be published. Economists are expecting 170,000, which would be a big fall form the huge 291,000 posed in January.
The US services PMI report and ISM non-manufacturing reports are tipped to be 49.4 and 54.9 respectively. The updates will be published at 2.45pm (UK time) and 3pm (UK time) respectively.
EUR/USD – rebounded late last month and if the bullish move continues it might target 1.1249. A pullback might find support at 1.1029, the 50-day moving average.
GBP/USD – has been pushing lower since late January and further losses might target 1.2600. A rebound might encounter resistance at the 50-day moving average at 1.3018.
EUR/GBP – rallied from mid-February and while it holds above the 100-day moving average at 0.8516, the outlook should stay positive, and it might target 0.8786. A move below the 0.8600 zone should bring 0.8516 into play.
USD/JPY – has been pushing lower for over one week and while it holds below the 200-day moving average at 108.40, the bearish move should continue, it might target 106.48. A retaking of the 50-day moving average at 109.56 could open up the possibility of 110.00 being targeted.
CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.