- The Fed delivered a dovish hold; implied yields across the Fed Funds futures strip have fallen
- Bank of England meets; two more rounds of voting by MPs will be held today
- Norges Bank hiked rates 25 bp to 1.25%, as expected; Bank of Japan kept policy steady, as expected
- Brazil, Indonesia, and Taiwan kept rates steady, as expected; Philippines central bank delivered a hawkish surprise
The dollar is broadly weaker against the majors in the wake of the FOMC decision. Swissie and Nokkie are outperforming, while the yen and Aussie are underperforming. EM currencies are broadly firmer. KRW and THB are outperforming, while INR and PHP are underperforming. MSCI Asia Pacific was up 1.2%, with the Nikkei rising 0.6%. MSCI EM is up 1.4% so far today, with the Shanghai Composite rising 2.4%. Euro Stoxx 600 is up 0.7% near midday, while US futures are pointing to a higher open. 10-year UST yields are down 1 bp at 2.01%, while the 3-month to 10-year spread has inverted 1 bp and stands at -15 bp. Commodity prices are mostly higher, with Brent oil up 2.3%, copper up 1.4%, and gold up 1.5%.
The Fed delivered a dovish hold. Rates were left unchanged, as expected. What was unexpected was that eight FOMC members now see rate cuts this year as appropriate vs. none in March. That number rises to nine in 2020. The end-2019 median Fed Funds remains at 2.375%, but the end-2020 median dropped to 2.125% from 2.6125% in March. Lastly, the median longer run Fed Funds rate is now at 2.5% vs. 2.75% in March.
The statement language was different as the Fed dropped its “patient” approach. Instead, the Fed pledged to “act as appropriate to sustain the expansion.” We also got the first dissent under the Powell regime, with one FOMC member calling for a rate cut. Markets took all these developments as a pre-commitment to cut rates in July. We disagree and continue to believe that the decision remains data-dependent.
After the FOMC decision, implied yields across the Fed Funds futures strip have fallen. The January 2020 contract is now at 1.60%, which is fully pricing in three cuts this year. The January 2021 contract is now at 1.26%, which is fully pricing in one cut next year and part of a second. This seems way too aggressive to us. These are not insurance cuts, these are recession cuts.
The dollar held up right after the decision, but weakness has picked up in today’s trading. DXY is nearing the June 7 low near 94.459 but first it must get through the 200-day moving average near 96.625. We remain bullish on the dollar due to our underlying optimism regarding the US economy. However, we must acknowledge that the dollar remains vulnerable until the US outlook becomes clearer.
During the North American session, the US reports Q1 current account, weekly jobless claims, May leading index, and June Philly Fed outlook. Of note, the jobless claims are for the June survey week containing the 12th of the month. Earlier this week, the Empire survey came in much weaker than expected and so markets will be watching for confirmation from the Philly reading.
Bank of England meets. No change is expected. Indeed, nothing is expected ahead of the October 31 Brexit deadline. We would go so far to say that the next hike is looking increasingly doubtful to the short sterling futures market. There, the next hike isn’t fully priced in until Q3 2023. Earlier, the UK reported soft May retail sales. Headline sales fell -0.5% m/m, as expected, while sales ex-auto fuels fell -0.3% m/m vs. -0.4% expected. Back months were revised down a tick.
Boris Johnson continues to dominate the Tory leadership vote. Boris Johnson got 143 votes in the third round vs. 126 in the second round. Runner-up Jeremy Hunt got 54 votes vs. 46 previously. Gove got 51 vs. 41 votes previously, Javid got 38 vs. 33 previously, and Stewart got 27 vs. 37 previously. That means the one with the least votes was Stewart and he is now out of the race.
Two more rounds of voting by MPs will be held today until there are only two candidates left. Voting then goes to a full vote of Conservative party members June 22, with the next Prime Minister to be announced July 22. Elsewhere, Labour leader Corbyn will reportedly push for a second Brexit referendum no matter what.
Norges Bank hiked rates 25 bp to 1.25%, as expected. It also flagged another hike before year-end, but Governor Olsen said he can’t be more precise on the timing. He added that he sees one last hike around summer 2020, which is consistent with the bank’s forward guidance that sees the policy rate topping out at 1.75%.
Bank of Japan kept policy steady, as expected. Some were expecting a more dovish tilt after the Fed and ECB, but there was no material change to its policy statement. Governor Kuroda said he wasn’t concerned by the recent drop in JGB yields, noting that the bank targets a range. However, he added that he is concerned about the impact of trade protectionism. We continue to believe the BOJ will wait until after the October consumption tax hike to add more stimulus. Next policy meeting is July 30 and no change is expected then.
Bank Indonesia kept rates steady at 6.0%, as expected. However, it was a dovish hold as the bank cut commercial bank reserve ratio by 50 bp even as Governor Warjiyo said that a cut was a “matter of timing.” Next policy meeting is July 18. If inflation remains under control as we expect, the bank is likely to start the easing cycle then with a 25 bp cut.
Taiwan central bank kept rates steady at 1.375%, as expected. It cut its growth forecast for this year to 2.06%, blaming a weak trade outlook. Governor Yang noted that while some nations follow US rates up and down, Taiwan doesn’t. This suggests that the bank may not cut if the Fed does. May export orders contracted -5.8% y/y vs. -6.0% expected and -3.7% in April, suggesting little relief in the next six months.
Philippines central bank delivered a hawkish surprise and kept rates steady at 4.5%. Another 25 bp cut was widely expected. The bank noted that a “prudent pause” would allow the bank to “observe and assess” the impact of previous easing. CPI rose 3.2% y/y in May, accelerating for the first time since September but still near the middle of the 2-4% target range. Central bank Governor Diokno has promised more easing and we still take him at his word. Next policy meeting is August 8. If inflation resumes its decline, a rate cut then is likely.
Brazil COPOM kept rates steady at 6.5% last night, as expected. The bank noted that external conditions had improved somewhat but added that progress on structural reforms was “essential” for interest rates to fall. Timing of a possible cut is tricky given the slow progress of pension reform in Congress, where we have penciled in Q4 passage. The CDI market is pricing in two cuts by year-end that would take the SELIC rate down to 6.0%, while the most recent weekly central bank survey shows market expectations for a year-end SELIC rate of 5.75%. Next policy meeting is July 31, which seems too soon for a cut.