Fed Turns Dovish, Dollar Steady, Central Banks In Focus

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More Fed Members Turn Dovish, Focus on Chairman Powell’s Monetary Policy Discussion

Talking Points:

  • Members within the FOMC are starting to divide between a more neutral or more dovish stance, hawkish views have diminished
  • USD to remain sensitive to Fed commentaries and trade war developments , the currency’s ability to push higher will continue to be subdued unless trade war talks provide some relief

As Fed Chairman Jerome Powell is due to speak later this afternoon about the economic outlook and US monetary policy, investors will be looking for any information regarding the size of the rate cut, if any, to happen in July’s meeting. Commentary from last week’s meeting indicated a change in the Fed’s stance as it dropped its “let’s be patient and see what happens” approach to become more “we will act as appropriate to sustain economic expansion”, confirming investor’s concerns about the outlook of the US economy and sending the dollar in a downward spiral . Markets are now pricing in a near 100% chance that rates will be cut by at least 25 basis points next month as many were expecting the cut to have happened already in the rate decision that took place last week.

FOMC members’ views are starting to divide

The decision to keep rates unchanged in the June meeting was not unanimous as Fed President James Bullard voted to reduce the rate for a final vote of 9 to 1. It is not much of a surprise that he voted in favour of reducing rates as he had already mentioned at a meeting on June 3 that rates cuts were to be “warranted soon” because of increased trade war risk, slowing global growth and sluggish inflation. And he may no longer be the only one to vote in favour of reducing rates next month, as Governor Lael Brainard suggested on Friday that she would support a reduction in rates to guard the economy against the downside risks it faces. Despite being a non-voting member Neel Kashkari could have significant influence at the next meeting as he stands as one of the more dovish members of the Fed together with Mr. Bullard. It is reported that he suggested a 50 basis point cut at last week’s meeting as he believes that an aggressive policy needs to be in place in order to “re-anchor” inflation expectations and tackle stagnant growth and inverted yield curves.

And more hawkish members of the FOMC may be losing a leg to stand on as economic conditions are only getting tougher for the US. In last week’s meeting the Fed pointed out that economic activity was rising at a moderate rate, which differs from the solid rate mentioned in the May meeting. Both the manufacturing and services industries are slowing as both figures are very close to the 50 line that marks a contraction in the industry, and although the jobs market remains strong, job and wage growth are slowing, and inflation remains below the 2% target.

But others within the FOMC still remain tilted towards the neutral “wait and see” stance as they believe that it is too soon to gauge how trade wars and growth uncertainty will affect the US economy. At the front of this group is Dallas Federal Reserve Bank President Robert Kaplan who has re-iterated that the Fed must wait and see what happens before making any decisions on rate changes. He believes that inflation will organically increase in the next 12 months as a stronger jobs market and increase in wages will push inflation higher despite the downward pressure on prices.

Central Banks’ power to influence the markets are diminishing

But there is no guarantee that rates will be cut at all this year as some suggest that the possible rate cuts hinted by the Fed last week could come in 2020 rather than 2020. The direction the FOMC takes in July’s meeting will be highly dependant on the outcome of Sino-American trade wars, as there is still hope that advancements could be made at the G-20 meeting in Osaka held on Friday. If we see a positive outcome, or even a trade deal, rates may not be cut at all in the near future as the Fed would rather allow the market to rebalance themselves before intervening. Of course, inflation and economic activity figures that will be released before the next meeting will be and important factor that the FOMC will be considering when deciding whether to change rates, but it seems that Donald Trump and Xi Jinping’s power to influence Central Bank monetary policies are only increasing.

Regardless of whether rates are changed or not the USD faces a difficult time as most outcomes will increase the downward pressure on the currency. If the FOMC members, including Mr. Powell at his speech this afternoon, turn further dovish and increase the chances of rate cuts in the near future the Dollar will suffer because it will confirm concerns about the state of the US economy and its future outlook. If commentaries from Fed members provide no future guidance about a rate change in July the Dollar will remain subdued to the uncertainty surrounding the future of the economy which will continue to drag it down against other major currencies, especially if no trade deal is reached this week and hopes of an end of trade disruption are diminished.

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— Written by Daniela Sabin Hathorn, Junior Analyst

Central Banks Turn Dovish, Boosting US Dollar and Accelerating Earnings Headwind

Feb 19, 2020 7:52 AM EST

Major central banks around the world are indicating an increasing need to ease policy as trade tensions accelerate a global growth slowdown, adding upward pressure to the U.S. dollar and another headwind to corporate earnings in the coming quarters.

Bank of Japan Governor Haruhiko Kuroda told lawmakers in Tokyo Tuesday that it was “crucial” to monitor the impact of currency moves on the broader economy, adding that the bank will “consider easing policy” if it sees it price stability ambitions at risk.

His comments followed a hint from from European Central executive board member Benoit Coeure last week in New York that there “might be scope” for another targeted lending program for the region’s banks amid a broader economic slowdown that looks deeper and more pronounced than the central bank had forecast back in December.

The World Trade Organization said Tuesday that its quarterly trade outlook indicator slipped to the lowest reading since March 2020 over the three months ending in December, while Germany’s ZEW Institute said that while investor sentiment in Europe’s biggest economy had improved, “we do not expect a rapid recovery of the slowing German economy”, adding that the economic situation “has been weak, especially in the manufacturing sector.”

Global fund managers are piling into cash, taking allocations to the highest levels in a decade, the February Bank of America Merrill Lynch survey of 218 investors controlling around $625 billion in assets revealed, as a net 46% expect global GDP to weaken over the next twelve months and 55% see secular stagnation as the consensus forecast.

The change in tack for both the ECB and the Bank of Japan follows not only persistent weakness in the global economy, but also an acknowledgement from the U.S. Federal Reserve in early January that it needed to be more “patient” with its plans to lift domestic interest rates.

However, while the Fed’s policy U-turn has clearly supported American equity markets — the SP 500 is up more than 9% so far this year — it hasn’t taken any steam out of the U.S. dollar, which has extended gains against a basket of its six global peers to gain just under 2% fro the year to date.

The U.S. dollar index also rose 1.1% over the three months ending in December, but ended the year 3.8% higher than the fourth quarter of 2020.

That move has had a big impact on U.S. corporate earnings, which are expected to shrink by around 0.3% from last year over the three months ending in March, as companies find it increasing expensive to repatriate overseas profits.

Coca-Cola Co. (KO) – Get Report shares, for example, fell nearly 9% over a single session last week after it posted fourth-quarter profits that were largely in-line with analysts’ forecast, but noted that 2020 organic revenue growth would slow and comparable earnings would likely remain flat thanks in part to a stronger dollar.

Johnson & Johnson (JNJ) – Get Report , International Business Machines (IBM) – Get Report and 3M (MMM) – Get Report also mentioned currency headwinds in their recent earnings updates.

Looking ahead, the strong dollar headwind might be further fueled by increasing global oil prices, which are hovering around the highest levels in three months after having gained more than 25% since their Christmas Eve trough as the impact of OPEC+ led production cuts offsets record U.S. output and slowing global demand growth.

“While it is tempting to look for a risk on, dollar off scenario (as investors put money to work outside of the US), it’s worth keeping an eye on crude prices, where Brent is now approaching $67/bl,” said ING’s global head of strategy Chris Turner. “Last year, US rates followed crude prices with a short lag and thus it would not be a surprise to start seeing US rates (e.g. two-year swap rates now 2.65%) pushing a little higher over coming weeks.”

“There’s also a case to be made that higher crude prices are also a relative Terms of Trade positive for the dollar as well,” Turner added.

Markets overview. Bank of England in focus, as Fed implements a dovish hold

Over the past few weeks global central banks have adopted a much more transparent easing bias against a backdrop of a slowing global economy. What is quite apparent from the data so far is that the slowdown is much more manufacturing based than services based, where economic activity hasn’t been anywhere near as subdued.

The recent decline in oil prices, also has the capacity to deliver a bit of a boost, as well as pressing down on some of the recent rise in inflationary pressure. Overnight the Bank of Japan maintained the status quo by leaving policy unchanged by a majority of 7 to 2.

The main story happened last night with the latest FOMC rate decision, with the markets front running a possible move towards an aggressive easing bias. This still seems a rather optimistic view point given that the Fed is still running down the size of its balance sheet, a process which is not due to finish until September.

Last night’s decision and subsequent statement and press conference, offered more questions than answers when it came to when and how the Fed was likely to move next.

Not surprisingly rates were left unchanged, however there was a dissenting view in the form of St. Louis Fed President James Bullard who called for a 25bps cut in the Fed funds rate. In terms of the outlook for the economy, the Fed kept its growth forecast unchanged, but did downgrade its inflation forecast, from 1.8% to 1 5%, while the dot plots for this year showed no change to the rate path.

The statement was also a lot more dovish in its outlook, the FOMC citing “uncertainties about the outlook” increasing. Against that backdrop the committee said they would closely monitor the implications of incoming information and act as appropriate to sustain the expansion, in light of muted inflation pressures.

The committee was also evenly split with eight seeing no change to policy this year, and eight expecting to see a rate reduction, with the one remaining member forecasting a rate rise.

It remains to be seen whether, as markets expect, we do get a rate cut in July, however the odds of a move appear to have increased in light of last night’s events. The reasoning behind such a move still remains a puzzle, given that the Fed will still be winding down the size of its balance sheet. Bond yields continued to move lower in the wake of the statement, as investors moved to price in the prospect of even more rate cuts.

In spite of the move in yields it still remains clear that any move will be very much data dependant which means the next payrolls and wages number is likely to be instructive. For all of this it is also apparent that markets are looking for more, in what increasingly looks like a case of the tail wagging the dog. As expected the Fed was dovish, however in response the market appears to have decided that it wasn’t dovish enough and is pricing in the prospect of the Fed having to do even more.

Despite the Federal Reserve’s dovish tilt last night markets still appear to be mispricing the pace at which the Fed is likely to move this year. While the change of tone in the statement was notable, and can be argued that a cut is now much more likely, there was nothing in the Fed’s tone to suggest that a cut in July was a done deal.

Yesterday’s UK inflation numbers didn’t offer much in the way of clues as to whether the recent noises coming from the likes of the Bank’s chief economist Andrew Haldane, and external MPC member Michael Saunders were likely to get any louder with respect to the prospect for higher rates.

If anything, the fact we slipped back to 2% means that the Bank of England is bang on target when it comes to its inflation mandate. This week’s unexpectedly dovish turn from the European Central Bank also makes it much less likely that the UK central bank will be in a position to hike in the near future.

ECB President Mario Draghi’s remarks earlier this week, may well have been slightly off-piste so to speak but nonetheless they remove any likelihood that the ECB will move in any other direction than lower in the coming months.

As for the Bank of England with the Brexit deadline extended to October and the latest economic data showing signs of softening, any talk of rate hikes is increasingly looking detached from reality, whatever these two policy makers might have you believe. That doesn’t mean we couldn’t see the bank try to adopt a slightly more hawkish bias, if only to try and put a floor under sterling after 7 weeks of declines against the euro.

EURUSD – appears to have found some support at the 1.1180 area and could well see a return to the 1.1270 area. The downside prevails towards 1.1110, while below the 200-day MA at 1.1370.

GBPUSD – could well have seen a short-term base at 1.2505, however we need to see a move back through the 1.2760/70 area to shift the emphasis to the upside.

EURGBP – feels like we may have topped out at 0.8975? A move through the 0.8870 level could well open up a move towards the 200-day MA at 0.8780, with 0.8820 interim support. While 0.8870 holds the risk is for a return to the highs this week

USDJPY – having found support at the 107.70/80 area we’ve edged back higher but need to push back through the 108.80 area to retarget a move to the 109.20/30 area. Bias remains to the downside and the 106.00 area, while below the 109.20 area.

Market Snapshot

Sue Chang and

Chris Matthews

Consumer prices rise at the fastest pace in 14 months

Minutes from the March meeting of Federal Reserve policy makers, including Chairman Jerome Powell, were the highlight of the U.S. economic calendar.

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U.S. stocks closed higher Wednesday, with the Dow Jones Industrial Average edging into positive territory just ahead of the closing bell, as the minutes from the Federal Reserve’s March meeting reassured investors that the central bank is in no hurry to resume raising interest rates.

How did the benchmarks fare?

The S&P 500 index SPX, +2.13% gained 10.01 points, or 0.4%, to end at 2,888.21 while the Nasdaq Composite COMP, +1.06% rose 54.97 points, or 0.7%, to close at 7,964.24. The Dow Jones Industrial Average DJIA, +2.12% edged up 6.58 points to 26,157.16 after spending most of the day in negative territory.

What drove the market?

The minutes showed that policy makers last month dropped plans for further rate increases in 2020 due to unease over the U.S. and global economies and unexpectedly tame inflation.

“A majority of participants expected that the evolution of the economic outlook and risks to the outlook would likely warrant leaving the target range unchanged for the remainder of the year,” the minutes said.

Meanwhile, the central bank remained sanguine about inflation.

Data released Wednesday morning showed consumer prices rose at the fastest pace in 14 months in March, though gains were muted when excluding volatile food and energy prices.

Investors were also monitoring a summit meeting of European Union leaders, where the main topic will be Britain’s attempt to stage an orderly exit from Europe’s trade bloc. The EU is set to discuss a potential long extension of the U.K.’s Brexit plans.

The European Central Bank earlier made no changes to monetary policy, as expected, repeating that it intends to leave rates at current levels until at least the end of 2020. ECB President Mario Draghi, in his news conference, said risks to the eurozone economic outlook remained skewed to the downside and that policy makers were willing to use all tools at their disposal if warranted by a deteriorating outlook.

On Tuesday, the S&P 500 snapped an eight-session win streak on fears over escalation of trade tensions with the European Union and a weaker global outlook from the International Monetary Fund.

The Trump administration threatened to impose tariffs on $11 billion worth of imports from the European Union, raising the specter of increased global trade tensions beyond the continuing U.S.-China spat.

What were strategists saying?

“I think there’s a bit more inflation beneath the surface than the market has been acknowledging,” Willie Delwiche, investment strategist with R.W. Baird, told MarketWatch. “The Fed is trying to be transparent and say ‘we’re going to be on hold right now and we are going to give what we’ve done over the past two years time to settle and see what happens. The market seems to think that if you are tilting toward a ‘wait and see policy’ you are actually preparing for rate cuts this year.”

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“In the past, the Fed has used minutes to clarify confusion over what it said” following the most recent meeting, Delwiche added, arguing that the Fed minutes could provide more clarity as to how the Fed is interpreting the latest data.

“The stronger 0.4% month on month rise in headline consumer prices, which drove the annual inflation rate back up to 1.9%, from 1.5%, was mainly due to the continued rebound in gasoline prices,” wrote Andrew Hunter, senior U.S. economist at Capital Economics, in a note.

“The further decline in core CPI inflation to a 13-month low of 2% in March, from 2.1%, underlines that there is little chance of inflation breaking out above the Fed’s target any time soon,” he said. “We continue to expect that weaker activity growth will convince officials to start cutting interest rates before the end of the year.”

What stocks were in focus?

Ride-sharing company Lyft Inc. LYFT, +4.69% shares sank 11% as investors focused on Uber Inc.’s plans for its own initial public offering. The stock has fallen more than 19% since Lyft’s March 28 IPO.

Uber is set to kick off its IPO market campaign, selling $10 billion in stock, according to a number of reports. That public debut is slated to take place as early as May on the New York Stock Exchange, according to reports.

Shares of Boeing Co. BA, +5.85% fell 1.1% after Intelsat SA I, +0.30% said it lost communication with its Intelsat 29e satellite, made by Boeing.

Apple Inc. AAPL, +0.15% shares rose 0.6% after HSBC downgraded shares to reduce from hold.

Shares of Levi Strauss & Co. LEVI, +8.98% gained 4% after the apparel designer reported late Tuesday its first quarterly results since its March initial public offering.

JetBlue Airways Corp. JBLU, +9.24% shares advanced 3.6% after the airliner reported a nearly 8% increase in traffic for March, though it said it expects revenue-per-available-seat mile to fall 3.1% in the first quarter.

Shares of Delta Air Lines Inc. DAL, +7.17% rose 1.6% after the air carrier reported first-quarter profit and revenue that surpassed Wall Street expectations while issuing an upbeat outlook.

How were other markets trading?

Stocks in Asia closed mostly lower, with Japan’s Nikkei 225 NIK, -0.03% retreating 0.5% and Hong Kong’s Hang Seng Index HSI, +1.37% losing 0.1%, while China’s Shanghai Composite Index SHCOMP, +0.37% added 0.1%.

European stocks closed on a mixed note as the Stoxx Europe 600 SXXP, +1.57% rose 0.3%.

In commodities markets, the price of oil US:CLK9 extended gains and gold futures US:GCM9 settled higher. The U.S. dollar DXY, -0.55% , meanwhile, traded mostly unchanged against its peers.

—Mark DeCambre contributed to this report

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