FOMC aftermath

Thursday, 2nd May 2019 10:56 - by Shant

As you were ladies and gentlemen . . . markets are back to their familiar lull, now awaiting the next tranche of US data after last night's FOMC announcement produced a neutral stance - as has been communicated by the Fed since the start of the year. Taking the meeting in context, up until the start of the year, the tightening cycle was set to continue but for Fed to step in and calm the financial markets as the prospect of higher rates clearly took their toll into Q4 of last year. 

Some may call in a dovish pivot - and yes in relative terms it is - but the fact remains that despite expectations of a rate cut at the end of the year, central bank policy remains in wait and see mode and all points to a steady rate profile as the Fed battle to contain any inflationary pressures coming through in the real economy while trying to appease equity markets. 

Last night's move to cut the IOER may have been seen as a precursor to an easing cycle, but in the press conference, Jerome Powell dismissed this notion and insisted - as many had anticipated - that this was merely a technical adjustment in response to the shift higher in the EFFR as a result of the decline in excess reserves.  The EFFR moved up to 5bp of the corridor ceiling, prompting the committee to ease this back towards the middle of the rate corridor.  Mid curve yields are still suggesting a cut at the turn of the year, yet the benchmark 10yr note is back above 250bps.  Going into the meeting, the Dollar was on the back foot while stocks pushed to new highs, and the reversal was immediate as market readjusted levels as we get back to the business of watching incoming data.  Non-farm payrolls will be the first major port of call, so until then, calm in Europe has highlighted the wait and see approach.

Yesterday's ISM manufacturing PMIs were reason for caution however, with new orders, priced paid and employment all seeing slippage in their respective indices.  The headline index fell from 55.3 in March to 52.8 in April, yet all measures remain in expansionary territory and a modicum of slowdown has been well telegraphed in recent weeks and months.  Equity markets failed to show any reaction unlike that of the Dollar, so we can assume that financial conditions remain the ultimate driver, though there is good reason to believe that fresh gains will be hard fought from current levels unless the underlying growth metrics throw up some material positives in coming weeks.  Hopes of a trade deal with China naturally add support for now, though we suspect the eventual accord - assuming there is one - will be scrutinised both in terms of how this will impact on China's debt/growth struggle and the ability to verify compliance. 

Concerns over Europe's economic slowdown may well be compounded by the upcoming elections - a risk which seems underappreciated - while trade talks with the US are yet another potential banana skin. Weakness in the single currency is reflecting this and adding appeal to the Dollar and its reserve currency status.  This is once again to the detriment of Gold price, which has taken another dip towards the recent cycle lows.   During its depreciation in 2018, analysts were in near unison over the preference for the Dollar due to the negative carry in holding Gold, so it is reasonable to believe that this proposition is revived in the near term.  Technically, the charts suggest that demand will pick up for the yellow metal in the $1200-1250 area, and represents good value here as a longer-term investment/hedge.  

In the meantime, Dollar dominance looks set to continue, and if some of the signals from US funding rates are to serve as a warning, potential shortages could prompt a sharp upturn in the greenback in coming months.  Emerging market currencies are showing the familiar strains and as we have seen before, provide the catalyst for a broader sell-off in risk assets.  Having tipped fresh record highs against widespread expectations that we had perhaps slipped into a bear market at the end of last year, complacency is creeping in again. If earnings have proved supportive up to this point, then it is worth noting that the Atlanta Fed GDP forecasts are pointing to a 1.2% growth rate in Q2.  Consequently, earnings projections are likely to show a degree of parallel ahead.  Should weakness ensue and prompt the Fed to act, selective USD weakness will be an easy assumption to make in theory, especially if the equity markets react positively.  However, correlations have never been so fragmented and sporadic, though repatriation flow and established safe havens will always, albeit eventually cut through 'noise'.