Friday, July 19, 2019

Fed officials raise the odds for a 50bps July cut, the Dollar tanks and equities rally

Tags
  • Dollar
  • Gold
  • Yen
  • Euro
  • Pound
  • Stocks
  • Oil

MORNING BRIEFING

Ultra-bearish comments from two Fed officials sent the Dollar lower in a hurry yesterday with the US currency losing ground across the board. The decline benefitted higher beta and safe haven currencies alike, with the Euro hitting 1.1280, Sterling climbing above 1.25 and the Yen advancing to 107.20 versus the greenback. US equities reversed earlier losses to close in the green as the dovish Fed remarks hinted on the potential of a 50bps cut at the end of the month and futures across the globe are pointing higher this morning. Gold received a fresh boost to the upside by the declining Dollar and rallied to $1,450 but Oil dipped further to reach $55.

During an academic speech, New York Federal Reserve President John Williams, who has spent his career researching how inflation behaves, hinted that current interest rates are way too contractionary, which suggests that he’s in favor of an aggressive reaction from the Fed. Even though his remarks were within the context of discussing an academic research paper, the timing couldn’t have been an accident. Moreover, later in the day his colleague Fed Vice Chairman Clarida added to the speculation when he said that the central bank needs to act quickly when the need for monetary easing arises. According to Clarida “when you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress”.

The Dollar dropped across the board after the two officials’ remarks as the bets for a 50bps cut in July soared. According to the CME FedWatch tool, the odds for a 50bps reduction at the end of the month are currently sitting at almost 50%, when they were at only 23% a week ago. Historically, the Fed has cut rates by a certain percentage when the odds for such a move were above 70% so there is still room to be covered, which is why our central scenario remains in favor of only a 25bps move. However, whether this will be branded as an “one and done” action is now under doubt and we will continue monitoring incoming data in order to reassess our view, if needed.

So what lies ahead for the Dollar? Clearly, this - perhaps coordinated - string of bearish views does weigh down on its outlook but today’s University of Michigan Confidence figures may help it recover a bit. More importantly though, next week’s fresh US figures will either solidify the case for a 25 bps cut or leave room for further speculation over a more aggressive move from the Fed. Expectations are mixed and the focus will fall on the US GDP levels, while the housing figures and PMI data mid-week will also be important.

Gold added another leg higher on the back of the bearish Dollar bias yesterday and made it to the $1,450 area. Obviously the yellow metal is benefitting from the decline in the greenback’s value but there are other supporting catalysts driving investors towards the safe haven instrument. There are $13 trillion in bonds out there that are offering negative yield to investors looking for protection amid a global slowdown - and a potential hedge against inflation from the upcoming central bank easing - so Gold’s zero-yielding nature appears rather appealing at this stage. This means that the rally doesn’t seem over at all and further Dollar weakness and signs of incoming inflation could propel prices to $1,470-90 in the near term.

Finally, equities are about to open in positive territory on the back of the fresh bearish remarks from the Fed. Despite a rather lackluster earnings’ season so far, investors are focusing on the prospect of a considerably easier monetary policy, which is why we see stocks ready to open higher this morning. Will the bullish bias last though? It should, at least in the short term. However, we sincerely hope that the Fed keep an eye on the economy and not the stock market because if their overly aggressive easing tilt is an attempt to keep equities supported, this would only create a more artificially-inflated environment that will pop later in the future.

MARKET EVENTS TO WATCH

  • University of Michigan Sentiment - 6pm

All times are GMT +4.

Written by Konstantinos Anthis, Head of Research