FXTM Chief Market
Strategist
After lowering interest rates twice in
2019, investors across all asset classes are awaiting the FOMC rate decision
when it wraps up its two-day meeting on Wednesday.
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What we learned from the September
meeting is that monetary policymakers are very divided. According to the dot
plot, five members agreed to the 25-basis point rate cut but wanted to stop
easing. Seven members agreed to the cut and were asking for another one in
2019. And another group of five opposed the decision to lower interest rates.
Despite all these conflicting
viewpoints, market participants seem convinced that another rate cut will be
delivered on Wednesday. According to CME’s Fedwatch Tool, markets see a 93.5%
probability of 25-basis point rate cut on Wednesday, and 22% chance of another
one in December.
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Given the recent deterioration in US
economic data, we agree with the market’s expectations that the Fed will lower
its benchmark rate on Wednesday. Job growth has slowed down significantly
compared to 2018. Wages were disappointing, with average hourly earnings little
changed in September and up just 2.9% for the year, the lowest rise since July
2018. When looking at manufacturing and services ISM numbers, they are also
painting a gloomy picture ahead. Meanwhile inflation surprised to the downside
in September keeping the annual CPI unchanged at 1.7% year on year.
Hawkish or dovish cut?
When the Fed started easing policy in
July, Jerome Powell said the rate move was a ‘mid-cycle adjustment’. If the
Fed delivers a rate cut on Wednesday it
will be the third and therefore the question becomes, is the Fed done with
their ‘mid-cycle adjustment’ and ‘insurance’ cuts or is this the start of a
more significant easing cycle? The
question may be answered in two ways, either in the statement accompanying the
decision or in Powell’s press conference.
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Should the Fed provide an outlook in
which it signals more easing may be on the way, then it’s no longer a mid-cycle
adjustment, and the Fed is now in full easing mode. This would hurt the Dollar
strongly versus its major peers as interest rate differentials drop which has
been a key factor in supporting the US currency.
However, I don’t think this would be
our base case scenario. While the US-China trade dispute has not been
completely resolved yet, there seem to be baby steps in the right direction.
Chances of the UK exiting the EU without a deal have fallen sharply after Members of Parliament
approved Johnson’s deal, but rejecting his timetable still means some
uncertainty ahead. Overall, the external factors that worry the Federal Reserve
seem to be abating currently and hence should have less impact on monetary
policy trajectory and policymaker’s decisions.
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While much of the US economic data has
deteriorated, it’s still not enough to signal a recession. Consumer confidence
remained high in October, suggesting that spending will continue to support economic
growth. Building permits jumped to a 12 year high in August indicating that
confidence in the real estate sector is still solid.
So, expect to see some changes in the
Fed statement, as leaving it unchanged will signal more easing ahead. Powell may be in a tricky situation, where he
needs to justify what the Fed has done is indeed a mid-cycle adjustment, whilst
also keeping the door open for further easing if needed. There’s no guarantee
on what happens next in trade negotiations, neither in the final outcome for
Brexit. That’s why traders and investors need to scrutinize every word Powell
says in his press conference.
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