Wednesday, July 31, 2019

Time has come for the Fed to cut rates: “one and done” or “more to come”?

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

MORNING BRIEFING

The most important day of the month - and potentially the year - is finally upon us. The 2-day FOMC meeting will be concluded today and the committee will announce their decision in regards to interest rates’ policy, followed by Jerome Powell’s press conference. We have spent the past few days explaining our thesis on why the US central bank will likely cut rates by 25bps today and, as we can see from the Dollar’s price action, such a decision has been priced in already. What matters now is what happens next and this hinges on two things: how the FOMC members cast their votes and how Powell delivers his forward guidance.

In our opinion, there are two major potential scenarios today: either the FOMC vote unanimously in favor of a 25bps cut and Powell delivers a cautious but optimistic message regarding the domestic economy’s outlook or a number of policymakers dissent by voting in favor of a larger cut and Powell leaves the door open for more cuts later in the year. Judging by the way the US central bankers voted last month, the odds for the latter scenario are considerable since 7 of them thought that a 50bps reduction in interest rates was needed until the end of the year. Since then, the US economy has seen some improvement in certain metrics like retail sales and employment but also continued weakness in growth and inflation.

As such, it’s evidently difficult to predict which way the vote will go today and how bullish or cautious Powell will sound. However, what matters more is what will happen in either case. So, in case of an “insurance” or “one and done” cut and accompanied rhetoric, the Dollar will extend its gains across the board. The European majors will come under pressure, especially given their domestic woes, while the safe haven Yen and Franc will also see more losses versus the greenback. On the opposite case, where a number of FOMC members feel that a more aggressive move was needed and Powell leaves the door open for more action in the future, then the Dollar will see strong selling action against its peers. We expect the low beta Yen and Franc to lead the charge, but any advance from the Euro and the Pound could be short-lived given a dovish ECB and elevated odds for a hard Brexit.

Gold edged higher over the past 24 hours and is now trading just above the $1,430 level. We were expecting this move higher to take place after the Fed delivered their rate cut but it seems that investors are pre-loading their longs ahead of the event. At the same time, the surge in the Oil prices is another contributing factor to Gold’s advance as a more expensive crude hikes inflation expectations to the upside, increasing demand for the yellow metal. In terms of what to expect going forward, we remain firm in our recent assessment: Gold could see a knee-jerk reaction to the upside when this [rate cut] becomes official but the way forward from there depends on Powell’s remarks. A positive tone, indicating an “one and done” approach that will keep rates steady for now will weigh down on Gold and we could see prices retreating towards the $1,400 area. Otherwise, a dovish takeaway paving the way for more cuts this year will set fire on Gold and drive prices to the $1,450 mark“.

Finally, equities are about to open marginally higher this morning ahead of the FOMC decision. Yesterday was a rather bleak day for the stock markets as President Trump’s comments on the lack of progress in the US-China trade dispute dampened sentiment. Nevertheless, equity traders will now focus on the most important event in recent months and the way forward depends on Powell’s forward guidance. “One and done” will not bode well for the stock markets but if the door stays open for more action later in the year, then equities will soar.

MARKET EVENTS TO WATCH

  • Eurozone Gross Domestic Product - 1pm
  • Eurozone Consumer Price Index - 1pm
  • FOMC Rate Decision - 10pm
  • Fed’s Powell Holds Press Conference After FOMC Meeting - 10.30pm

All times are GMT +4.

Written by Konstantinos Anthis, Head of Research