Wednesday, October 30, 2019

UK’s general election set for December; will the Fed change its tune on monetary policy?

  • Dollar
  • Gold
  • Euro
  • Pound
  • Stocks

Market recap: Investors temper their US-China trade pact expectations

US equities fell yesterday after a US administration official claimed that a trade pact between the US and China may not be confirmed in time for the Asia Pacific Economic Cooperation Summit in mid-November, although that does not mean the accord is falling apart. Investors reacted to the news with caution, as the statement raised more questions over how much progress the two superpowers are actually making when it comes to the ongoing trade war. The DJIA and S&P 500 closed slightly lower, falling 0.07% and 0.08% respectively. The Nasdaq fell 0.59%, dragged down by disappointing earnings reports from Alphabet and Akamai.

In the UK, British Prime Minister Boris Johnson won the majority vote he needed to call for a general election on December 12th. The UK’s House of Commons voted 438 to 20 in favour of the bill, with Labour Party leader Jeremy Corbyn agreeing to back the call for an election after the EU confirmed the Brexit deadline has been extended to January 31st 2020. Now, the election bill simply needs to be rubber-stamped by the House of Lords. Investors will likely remain cautious ahead of the election in December, as Johnson attempts to regain a majority in Parliament so that it will be easier for him to pass his Brexit withdrawal bill. Cable remained mostly flat, losing 0.01% on Tuesday.

Safe haven assets saw little change on Tuesday, with gold only dropping 0.05% and the yen weakening 0.05% against the dollar. US treasury yields were flat across the board.

Meanwhile, major indices in Asia started the day mixed, as the Nikkei and Hang Seng Index opened Tuesday’s trading session 0.09% and 0.07% lower, while the Straits Times Index gained 0.20%.

US Automatic Data Processing (ADP) Employment Change and GDP data will come out later today at 4.15pm and 4.30pm (GMT +4) respectively.

Today’s analysis: A 98.3% probability of a Fed rate cut is being priced into markets

Fed officials are set to meet on monetary policy later today, with its decision scheduled to be announced on October 30th at 10pm (GMT +4). The Fed cut rates by 25bps at September’s meeting, the second straight cut of the year. The market is expecting a third from today’s meeting.

FED Fund Future's implied probability of a rate cut

Since the last monetary policy meeting, economic indicators have further shown that the US economy is experiencing a slowdown. This is likely a result of the ongoing trade dispute, which is causing businesses to hold back on employment and investments because of uncertainty surrounding trade.

US domestic economy showing signs of slowdown

We expect the Fed to cut rates today, partly so it doesn’t disappoint the market, and also to act as an insurance policy for the economy. As Fed Fund Futures indicates an implied probability of 98.3% that there will be a 25bps rate cut, investors will instead most likely focus on the Fed’s tone for future decisions on monetary policy.

The Fed is likely to shift toward a slightly hawkish tone without dismissing a future rate cut. But don’t expect a cut in December unless this week’s economic data (GDP, Employment and the Purchasing Managers’ Index data is set for release) largely misses consensus. In this case, expect the dollar to only slightly strengthen against major currencies, with the Dollar Index rising to 98.00’s level, as this scenario is mostly within markets expectations.

If the Fed’s tone appears to be dovish then expect the dollar to weaken, with the Dollar Index possibly dropping to 97.23’s level.

But the Fed keeping rates unchanged is not impossible. The effects of the previous two rate cuts are likely not fully reflected on the economy just yet and divide between Fed officials on more rate cuts may signal a possibility to leave rates unchanged, although it is unlikely. If rates are left unchanged, then the Dollar Index may surge to 98.44’s level.

Will the Fed's decision today support the bulls or bears? (H4)

Traders are cautious ahead of the Fed’s monetary policy announcement. If it announces a “hawkish cut” then expect the dollar bulls to push the Dollar Index up slightly to 98.00’s levels. But if the Fed does not change its tone after cutting rates, then the bears will apply downward pressure on the Dollar Index, breaking the 97.65 support level to range between 97.36 and 97.65.