Market recap: All eyes on Feds decision later today after the Fed surprisingly ran repo overnight
Ahead of the FOMC meeting, cash available to banks for short-term funding needs dried up earlier this week, interest rates for overnight lending and repo rates of the US market soared as high as 10%, more than four times the Fed’s 2.25% target rate. The New York Fed therefore made an emergency injection of $53 billion worth of various debt instruments (i.e. repurchasing operation: repo), the first time since 2008 financial crisis, to prevent borrowing costs from spiraling even higher. The Fed also announced plans that it would carry out a second repo on Wednesday ($75 billion) to inject liquidity into the system again.
The “repo” move raised concerns over whether the Fed is capable to control money markets and investors expected that the Fed may announce further measures to relax Interest on excess reserves rate (IOER) and cease to shrink its balance sheet, or even signals to plan the restart of QE program in a bid to bring more liquidity to the bond market. The dollar index fell by as much as 0.38% on Tuesday.
Wall Street closed higher on Tuesday, with DJIA up 0.13%, S&P500 rising 0.26% and Nasdaq increasing by 0.40% from the previous day. The increase in stock prices was likely because of the news that Saudi Arabia announced that almost half of the production cut by Saturday’s attacks had already been restored and that production capacity would be up to 11 million barrels per day (bpd) before the end of the month (compared to 9.6 million bpd before the attacks). As a result, oil prices sank with US WTI Crude Oil price falling as much as 5.7% and International Brent Crude price pulling back sharply by 6.5%.
Bond markets pulled back as yields reduced across the curve. 2 year yields fell to 1.73%, 10 year yields fell to 1.81% while the 30 year yields fell to 2.27%. Safe haven assets remained relatively flat as investors waits on the Fed’s announcements after its meeting later today.
Today’s analysis: Optimism on rate cuts fade on surging oil prices
The Fed is scheduled to announce its decision on monetary policy later today at 10:30pm (GMT +4). Analysts originally expected rates to be cut by at least 25bps, with Fed Fund futures indicating that the probability of a rate cut was as high as 92.3% a week ago, whilst now dropped to 54.2%. The drop of probabilities is likely due to more positive economic data, the surging oil prices and short-term positivity on the US-China Trade dispute.
As oil is a major input of the economy, it correlates closely to inflation rates. High oil prices will increase costs of production and services in industries such as transport and manufacturing. The increased cost is likely to be passed on to the consumer, which in turn will drive inflation rate higher (currently 1.70%) to towards the Fed’s target rate of 2%.
In addition, recent economic data released also indicates that the US economy may not be as negative as implied. Retail Sales beat estimates, advancing 0.4% over the previous month. Tuesday manufacturing production rose 0.6% last month after an unrevised 0.4% drop in July. Unemployment rate in august also maintained about 40 years low at 3.70%. The University of Michigan’s consumer sentiment preliminary results also beat estimates of 90.9. Core CPI inflation laid at the highest level since the recession ended in August, reached 1.7% reversed two-sessions fall. Most of the economic data seem less supportive of a rate cut today or further rate cut by the end of the year, despite economic instability arising globally.
Furthermore, the FOMC decision made to cut rate in July is actually having an 8-2 mixed and divided votes; Chairman Powell also indicated it as a “mid-cycle” adjustment, instead of part of a series of easing or a larger rate cutting cycle.
Therefore, we expect the Fed may stay the current target rate 2%-2.25% unchanged today, slightly different from the current market is projecting. At the same time, we believe the Fed may announce plans and decisions regarding more easing policies, such as relaxing IOER rate, ceasing the current shrinking of balance sheet or even expanding it.
Dot plot will be another main focus: would there be 3 times rate cut in the year?
September FOMC meeting is usually a stunning one as the Fed policymakers need to deliver their own views of where rates should be by December, by publishing a dot-plot forecast. In June, the last time they published their forecasts, about half of policymakers expected a total of two rate cuts this year; whilst about half thought no rate cuts would be appropriate, which proven that the Fed’s views are very divisive than the market thought.
The majority of the traders believe that after the September rate cut, there should still be one more time rate cut as they believe the Fed is going to call for more easing. However, it is expected that Chairman Powell and the Fed policymakers will only deliver concerns over the shrinking economy, instead of sending out strong signals to imply more cuts by the end of the year. Powell may even signal a data-dependent approach to future cuts in his press conference, buoying the dollar as expectations of a December rate cut may also be reduced after the meeting today.