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Daily Fix: Relief seen as Powell pre-announces rate cut

Chris Weston
Head of Research
11 Jul 2019
A couple of Federal Reserve speakers offering a more nuanced tone on their policy outlook, and the market starts to question if the Fed will cut in July. Subsequently, the market fades an overbought bond market; we see a modest rise in implied volatility, and heat comes out of rates, gold and the equity rally. It's one big liquidity and hunt for yield trade.

A couple of Federal Reserve speakers offering a more nuanced tone on their policy outlook, and the market starts to question if the Fed will cut in July. Subsequently, the market fades an overbought bond market; we see a modest rise in implied volatility, and heat comes out of rates, gold and the equity rally. It's one big liquidity and hunt for yield trade.

Well, Fed Chair Jerome Powell has put that idea to bed. We’re are all firmly back on the 25bp or 50bp cut debate, with Powell effectively pre-announcing a rate cut 31 July (or 1 August at 4 am AEST).

After all that was said, we’ve seen the August fed funds futures rally 6.5bp. We’re now left with markets pricing a 24.5% chance of a 50bp cut in July, with a total of 90bp (of cuts) priced through the coming 12 months. A huge relief for all that, perhaps, is we may start to focus on fundamentals again. We saw US two-year Treasury’s -8bp, and down by another 2bp here in Asia, to current sit at 1.80%. This has been the catalyst for a broad USD selloff, with USDNOK being the big mover in G10, helped by a chunky move in Brent and WTI crude.

The Phillips curve is redundant

There’d been a view that the recent US payrolls report provided less scope to ease in July, but Powell detailed that it didn’t alter the bank’s thinking. That’s important, and it’s clear the Fed is seeing less and less evidence that a tight labour market is generating the necessary wage pressure. The Phillip’s curve, it seems, is redundant. Global growth concerns are, again, the overriding theme, which was the message we also heard loud and clear in the FOMC minutes — with the minutes complimenting the message we heard from Powell.

Global growth and external fragility were also themes prevalent in the Bank of Canada meeting. One questions how much damage the trade tensions have done to the corporate landscape that still needs to play out in the data flow.

USDJPY following US Treasury's

USDJPY has been well traded of late, and we can see from the price action on the daily that traders were closing USD shorts into Powell’s speech. It’s been a tough night for USD longs, though, with price closing firmly below Monday’s low and printing an outside day. We’ve seen follow-through selling through Asia today, and one questions if this is a genuine insight into how the USD may act going forward. Let’s see how tonight’s US CPI fares (22:30 AEST), with consensus calling for no growth in June at a headline level, and a 0.2% increase at a core level. A miss here would throw fuel on the fire of a 50bp cut. But it’d need to be a sizable miss to really see economists change their calls to 50bp, but it’s a risk for traders.

USDJPY daily - July 11, 2019

In the options world, we can see traders have been bearish USDs for a week or two, with three-month risk reversals (the white line) at the lowest levels since Q118. Risk reversals effectively look at the difference between the demand for out-of-the-money (25 delta) put options relative to call (25 delta) options. It shows us that options traders see a higher probability of USD downside over the coming three months than upside, and has actually been a good leading indicator for the USD over the years.

USD index 3mil risk reversals

"Source: Bloomberg"

Trump looking at how to promote a weaker USD?

Reports (source: CNBC) that Trump has asked his aides to find a way to weaken the USD have been talked about on the floors, although we’re also led to believe chief economic advisor Larry Kudlow and Treasury Secretary Steven Mnuchin are not on board with these plans. Either way, it’s hard to sell USDs that Trump is going to impact the USD in isolation, but we watch with interest in case he does, as it’d have huge implications.

Gold back in vogue again

Gold has benefited from the fall in nominal, and real (or inflation-adjusted) yields and the gold bulls will be happy to see US$1,381 hold, as a break here would have triggered a more protracted drawdown. As it’s, we’re back at the top of the recent range, and looking for a firm close above US$1,425. Granted, we’ve been higher on an intra-day basis. But on both occasions, gold sellers faded the move quite aggressively. So, a close through US$1,425 would give us an indication that the bullish trend is getting a new lease of life.

Certainly, ASX 200 gold stocks have warmed to the moves in the yellow metal, in a tape in the broader ASX 200 that’s largely unconvincing, with the bulk of the buying playing out in energy. That won't surprise given the huge 9.4mil draw in the weekly Department of Energy inventory report overnight, which has spurred the crude price to rise above US$60. However, we see the ASX 200 up 0.1%, held back by the financial sector, which is subtracting 7.4 index points. Moves by the Australian Prudential Regulation Authority demanding three of the big four banks hold increased capital aren’t enthusing investors, although it's unlikely to act as a pronged headwind.

The rest of Asia is in better shape, with the Nikkei 225, Hang Seng and CSI 300 up 0.4%, 1.2% and 0.8%, respectively. On the other hand, though, it’s hard to find anyone who was overly impressed by the price action in the S&P 500. Granted, the S&P 500 closed at a new high, which is naturally bullish. But the index gave up the 3,000 a bit too easily, and cyclicals underperformed defensive sectors. That said, S&P 500 and Dow futures are tracking higher in Asia. And, indeed, our opening calls for European equity open are looking quite constructive here. Into Q2 earnings we go. The outlooks from CEOs, especially those who have been affected by Trump’s tariffs, will be incredibly interesting and potentially influential.

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