Powell’s Pre-Emptive Policy Adjustment

The dollar surges to 2-year highs as a hawkish Fed cut rates but push back on the idea of an easing cycle, as focus turns to today’s BoE rate decision.

Previous Day's Market Highlights

Wednesday's main event, the Federal Reserve's latest monetary policy decision, saw the market get some, but not all, it wanted; with the FOMC announcing a 25bps rate cut, but indicating that this is not the beginning of a prolonged easing cycle. The FOMC's first rate cut in more than a decade, bringing rates to 2.00% - 2.25%, was not a unanimous decision, with hawkish dissent from committee members George and Rosengren voting to keep policy on hold. The Fed also altered their balance sheet run-off, or quantitative tightening, programme, announcing that the reversal of crisis-era quantitative easing will conclude today. Such an action is to be expected with the Fed not wanting to loosen conditions through a rate cut, while simultaneously tightening them through a shrinking balance sheet. Despite the rate reduction, the Fed's assessment of the US economy remained broadly unchanged from the June FOMC meeting; affirming that economic activity is rising at a 'moderate rate' and that the labour market 'remains strong'. With the economy currently giving little cause for concern, the rationale for cutting rates was given as concerns over global developments, presumably US-China trade relations. Hence, this rate reduction should be seen as an insurance cut, or, to quote Fed Chair Powell, a "mid-cycle policy adjustment".
 
Of more importance to markets than the immediate rate decision, which had been fully priced in, is the Fed's policy outlook. In both the monetary policy statement and post-decision press conference, the FOMC struck a relatively hawkish tone, remaining upbeat on the US economy and framing yesterday's rate reduction as a pre-emptive measure; casting doubt on the market's current pricing of another 2 rate cuts this year. While the Fed appear to maintain a bias for lower rates, as shown by the FOMC once again stating it will 'act as appropriate', a prolonged easing cycle is not to be expected, with Chair Powell pushing back on such a rate path, while also indicating that the Fed may not cut just the once. Though the comments on the outlook are fairly vague, and give policymakers room to manoeuvre, my base case remains another 25bps reduction in September, before policy being left on hold - barring a significant escalation in US-China trade tensions. For the dollar, the Fed's more hawkish than expected tone sent the greenback 0.6% higher against a basket of peers, settling around a 2-year high.

Elsewhere, a number of important eurozone releases were overshadowed by the Fed's policy decision. Data showed the pace of price increases, as measured by CPI, increasing at the slowest pace since February 2018 in July, increasing at just 1.1% YoY. Meanwhile, economic momentum remains weak, with GDP increasing by just 1.1% in Q2, the slowest pace since the final quarter of 2013. On the whole, the releases do little to alter the chances of ECB policy stimulus being delivered in September. The single currency ended the day 0.8% lower against a stronger dollar, falling below the $1.11 handle for the first time in 2 years. Meanwhile, the pound experienced some month-end demand, helping sterling to recover some ground. The pound closed 0.8% higher against the euro, the 1st gain in a week, however closed unchanged against the dollar, giving back earlier gains after the FOMC decision. All other G10 currencies ended the day around 0.5% lower against the greenback.
 
Away from FX, European equity markets closed marginally higher, the pan-continental Stoxx 600 up 0.2%, ahead of the FOMC rate decision. However, US markets lost ground as the prospects of significant policy easing faded, with the benchmark S&P 500 losing 0.7%. Finally, oil prices firmed after data showed a larger than expected draw on inventories. Both benchmark Brent and US WTI crude gained over 0.75%.

Currency Pairing 08:00 Today Vs 08:00 Yesterday Four-Week High Four-Week Low % Change
GBP/EUR 1.0985 1.1246 1.0875 3.30%
GBP/USD 1.2125 1.2587 1.2100 3.87%
EUR/USD 1.1040 1.1285 1.1033 2.23%
GBP/AUD 1.7720 1.8041 1.7560 2.67%
GBP/NZD 1.8505 1.8960 1.8278 3.60%
GBP/CAD 1.6030 1.6445 1.5959 2.96%

Today's Market Highlights

After yesterday evening's Fed rate cut, focus switches to Threadneedle Street today and the Bank of England's (BoE) latest monetary policy decision. Expectations are for the BoE to leave rates on hold at 0.75%, with policymakers likely to vote unanimously for such a decision as their hands remain tied by Brexit-related uncertainties. Despite the uncertainties, the BoE are likely to continue to maintain their tightening bias, reiterating that 'gradual and limited' policy tightening will be required in the event of a smooth and orderly Brexit. Markets, however, take a different view, pricing in a roughly 50% chance of a rate cut by year-end. In the unlikely event the BoE want to send an explicitly hawkish message, expect Carney to push back on the market implied rate path in the post-decision press conference. In addition to the rate decision, with today being a Super Thursday event, market participants will chew over the Bank's quarterly Inflation Report, including the BoE's latest economic forecasts. Growth forecasts may be downwardly revised in light of Brexit-related uncertainty and subdued business investment; however, inflation and unemployment forecasts should be left unchanged. For the pound, the policy decision poses more downside risks than potential for upside movement. The BoE maintaining the status quo would likely result in limited reaction for sterling, however a more cautious tone would likely be met with the pound coming under pressure, being seen as policymakers effectively endorsing the markets' dovish rate pricing.
 
Elsewhere today, manufacturing PMIs from the majority of major global economies will be eyed as a useful leading indicator of economic performance. Broadly speaking, the data should show manufacturing activity remaining soft, with the industry continuing to contract. Breaking the data down country-by-country; from the eurozone, final data for July is set to confirm a 6th consecutive contraction, the PMI set to remain unchanged from the flash estimate of 46.4. Meanwhile, the UK's manufacturing sector is set to slip further into contraction, the PMI expected to fall to 47.7, which would be the lowest level since late-2012. Across the pond, the Canadian manufacturing industry is set to contract for a 4th consecutive month, while the US ISM PMI survey is expected to modestly tick up to 52.0, signifying a sluggish pace of expansion. Across the globe, a softer set of PMI figures will likely fuel concerns over slowing economic momentum, potentially increasing expectations for even more dovish monetary policy stances going forward.
 
Barring the manufacturing PMI releases, the calendar is relatively empty. Markets will likely glance over this afternoon's US weekly jobless claims figures, expected broadly in line with the 4-week average of 213k, while also digesting the overnight release of minutes from the BoJ's recent policy decision. Despite the heavy data calendar, the overriding theme for the day will likely be markets continuing to digest the Federal Reserve's policy decision.

Today's Economic Calendar

Time Currency Release Consensus Previous
9:00am EUR Final Manufacturing PMI (Jul) 46.4 46.4
9:30am GBP Manufacturing PMI (Jul) 47.7 48.0
12:00pm GBP Bank of England Rate Decision & Quarterly Inflation Report 0.75% 0.75%
12:30pm GBP BoE Gov. Carney Press Conference 1.0% 1.1%
1:30pm USD Weekly Jobless Claims (Jul 26) 214k 206k
3:00pm USD ISM Manufacturing PMI (Jul) 52.0 51.7