The world was watching Fed Chair Powells appearance before congress. By all accounts, Powell provided a clear signal for an imminent reduction of the Feds fund rate. The USD reacted by losing value against all G10 currencies. Powell’s reiterated the word “uncertainty” five times to higher the risk of a global slowdown. He went on to say “manufacturing, trade, and investment are all weak all around the world”. In regards to the strong June payroll report, which cause so much doubt into the projected Fed dovishness, was "great" news but would not tip the balance on soft wage growth and declining inflation.
Minutes from the prior FOMC meeting all indicate member wants a more accommodating policy. July rate cut is now a near certainty. There are lingering questions over whether the Fed will reduce by 25bp or 50bp.
In our view, a 50bp cut is to larges a step. The US economic data has not decelerated at an alarming pace and judging from solid NFP read still has momentum. In broader strategic terms, the Fed has been cautiously tightening interest rates over 4 years. It unlikely they would panic because of marginally softer economic data. We had predicted that much of the hikes were to recover tools to combat a financial calamity. In our view, this psychology remains a critical part of the monetary policy calculation framework. A 50 bps cut would send the wrong negative message to the market. Bloomberg is now predicting a 23% probability of a 50 bp cut in Fed July meeting, which is too high in our view. There are plenty of signs of slowdown and end-of-cycle is more likely than dip and reacceleration, which we have seen for the last 10 years. Yet, Fed panic in reaction to natural slowdown is inappropriate.
Equity markets rallied on Powell’s testimony with the S&P 500 hitting 3000 record regions. There was less activity in the US bond curves as the short end yields fell by 7bps but the 10 year was unchanged. Moving forward, we are less bearish of the global economic outlook than many of our peers. Easing monetary policy by the world’s central banks should backstop economic weakness and provide a boost to risk appetite. While short term news cycling might provide volatility in the longer-term positive dynamics will dominate.
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