Thursday, June 20, 2019

Fed signals two rate cuts this year but why didn’t the Dollar sell off?

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MORNING BRIEFING

The Dollar falls on the back of the FOMC rate decision and Powell’s press conference as the takeaway from the 2-day meeting was clearly dovish. The US currency moved lower across the board and 10-year yields now dropped below the 2% mark after the US central bank opened the door for a round of rate cuts, starting as soon as next month. All other major currencies gained as a result while the British Pound comes front and center today ahead of the Bank of England’s meeting on monetary policy. Equities were mostly positive yesterday and futures point towards a bullish opening bell, Gold almost hit $1,400.

The Federal Reserve decision on interest rates’ policy was even more bearish than what consensus expected. Obviously no one expected the Fed to cut rates during their meeting this month but the speculation was on whether they would hint on a potential move in July or September. The US policymakers went one step further though: one member of the committee voted for an immediate rate cut yesterday, 8 are now seeing the need for lower rates until the end of the year and 7 out these 8 even look for two rate cuts in 2019 as the appropriate policy reaction.

It is evident that the Fed has noticed the deterioration in the domestic data alongside the persistent geopolitical risks still on the horizon and they now feel that they should act. What makes things more interesting is that the majority of the committee doesn’t predict only one cut, which would fall in line with the rhetoric that they should probably take a step to ease conditions in order to sustain the expansion of the economy. In our opinion, the mere fact that most of the US policymakers are already looking for 2 moves this year justifies our view that the domestic economy has been slowing down materially and aggressive easing is needed to avoid going into a recession.

The Dollar declined across the board following this decision and the release of the Fed dot plot which indicated the majority’s view that 2 cuts are justified. However, the greenback’s slide didn’t turn into a selloff and we believe this is down to two reasons: first, Jerome Powell put on a brave face during his remarks and still talked about the positive sectors within the economy, easing the bearish sentiment. Second and most important though, we think that the Dollar’s measured reaction is due to investors knowing that this is not a US-specific downturn in growth but rather a part of a global slowdown.

In an environment of synchronized easing in growth, the Dollar would receive strong inflows coming from higher beta currencies as investors would look towards safer havens. With Europe indicating arguably worse growth prospects and China coming under pressure from Trump’s trade war, affecting the commodity currencies too, the greenback would eventually come out stronger. This train of thought would explain why the selling action was underwhelming against the rest of the majors and also why Gold exploded to $1,400. As such, we do think that the US currency will see more downside ahead against the likes of the Japanese Yen and the Swiss Franc but we see less of a chance for a sustained decline versus the Euro, the Pound and the antipodeans.

Meanwhile, Sterling will take center stage today as the Bank of England will release their decision in regards to interest rates. It’s important to note that the BoE remains on the bullish side and expects to raise interest rates when Brexit is resolved in order to arrest the high levels of inflation in Britain. This, however, comes in stark contrast to what the rest of the major central banks around the world plan to do, so it will be very interesting to see whether Carney will remain true to his preference for more tightening in the foreseeable future.

Gold jumped to $1,394 last night when the overall bearish takeaway from the FOMC meeting drove the Dollar lower. The yellow metal benefits from the decline in the US currency and the drop in US Treasury yields and the question to ask is whether these gains would last. The break above the $1,360 resistance is a material change in the instrument’s technical outlook so if this remains valid over the next few days, then Gold would establish a new trading range between $1,360 and $1,400 in the medium term.

Finally, equities ended the day with small gains yesterday but already this morning futures on both sides of the pond are pointing higher. It makes sense for stocks to advance in an environment of lower expected interest rates but what would be important for investors to also ponder is whether this is a sign of an economy that can’t sustain its growth rate anymore. We have called for a continued deterioration in domestic growth in the US over the next 2 quarters and if we prove to be right then equities may enter a bear market when this becomes apparent. In the meanwhile though, equity traders seem to be buying the “lower rates to support the expansion” story so the near-term direction for the US indices should remain positive.

MARKET EVENTS TO WATCH

  • UK Retail Sales - 12.30pm
  • Bank of England Rate Decision - 3pm
  • US Initial Jobless Claims - 4.30pm

All times are GMT +4.

Written by Konstantinos Anthis, Head of Research