So, rates are coming down, well eventually. We knew that anyway. Powell said as much anyway, Lael Brainard has said so and so too Trump. Why should the market react this way? It’s not really new news. The answer lies somewhere between expected news and announced.
So, what is happening? Well, the dot plot changes and the fact that there will be no expected rate hikes this year probably says more about trade tariff policies and the impact of those tariffs on the global economy. Currencies reacted and the dollar index was a tad weaker on the day. So, the key elements are the taper of the balance sheet commences May dropping the cap on monthly redemptions from $30 bio to $15 bio and will stop in September.
This should help bank reserves and certainly will be positive for SOFR rates. The net effect is a slight loosening. The Fed will allow the balance to decline via maturities. It also intends to roll its maturing holdings of mortgages into treasuries and this is capped at about $20bio per month.
The interest here is that this may foreshadow the next move by the Fed to possibly use its latest tool, the much vaunted “standing repo facility”. The facility is intended to allow the Fed to hold cash rates at a much tighter level to Fed Funds. How it operates is still under a cloud as the Fed is still in discussion with primary dealers and banks.
The news is not unexpected. What is unexpected was the Fed’s decision to not raise rates for the year. Another point of interest is the vote was 10-0 to hold rates steady between the target range of 2.25% and 2.5%. The policymakers revised their economic growth forecast for this year and next year at 2.1% which is a full percentage point below 2018’s pace and was a downgrade from an earlier forecast of 2.3%. Inflation is expected to remain at 1.8%compared to an earlier forecast of 1.9%.
Policy makers now expect to raise rates in 2020 and hold steady until 2021. The CME Fed Fund Futures is not pricing those rises at all with a 52.7% probability of a rate cut expected on 29 January 2020 (the first policy meeting for the Fed in 2020) and no change throughout 2019.
Bonds staged a neat rally on the back of the FOMC decision. Interestingly, one of those indicators of economic gloom, the 2/5 spread, just inverted further. That spread and the 2/10’S are moving rapidly. The 2/10 flattened a further 1.4 bp on the day while the 10-year raced towards a 14-month low. The yield spread between the 10-year and the 10-year TIP (Treasury Inflation Protected Securities) was 1.97%, the highest since December. The view is, really because the Fed won’t be tightening. And besides, mid-2020 is a long way away and markets will no doubt change over time.
The reaction on the stock market was to shift stocks out of their torpor and unleash a short sharp rally. Tech and energy stocks surged but financials and healthcare dragged stocks back to some form of reality. Stocks generally reflected the changing pallor of the U.S. economy.
FedEx Corp was down 3.5% after it cut its forecasts and cited slowing growth. Logistics companies are very good forward indicators to economic strength, and this is an interesting pointer. UPS also fell by 2.2%. Trading on the day was good was above the 20-day average with some 7.76bio shares changing hands versus an average of 7.53 million shares.
Elsewhere, the news was not so good. Bayer was clobbered because a U.S. court ruled that glyphosate used in its weed killer could cause cancer. A large sum payment is expected and so too a raft of copycat court cases. Bayer possibly should be allowed these cases to conclude before taking over Monsanto, the manufacturer of the weed killer at the heart of the court case. It had a large fall, and this dragged the Stoxx European 600 down. Bayer fell 9.6%.
Brexit woes continue and the UK is looking more akin to a punching bag because of Parliament’s inability to do anything other than remain in its current stasis. Even Donald Trump Junior has weighed in telling anyone who wanted to listen that May should have taken his dad’s advice.
The rally in U.S. treasuries could not have come at a worse time for UK banks. With the uncertainty surrounding Brexit and the requirement to meet prudential safeguards, the demand for AAA assets has skyrocketed.
The banks must withstand a 100-day market stress rather than the now defunct 30-day stress. Some lenders have been asked by the BoE to triple their holdings in triple A rated bonds as a safeguard to a chaotic Brexit exit. KfW has taken advantage of this by selling sterling 4.5bio of bonds this year already to tap demand stemming from UK bank treasuries.
And for those looking for a quick fix on the China -U.S. trade deal, then look again. Trump has stated, and this is probably what China fears, tariffs will remain until China complies with the deal. Tariffs won’t roll off just yet and it is unknown how long these tariffs will remain after some agreement has been made. This is a typical Trump tactic in that you never know if you actually have a deal. For the Chinese, they must be bamboozled.
A development to follow is the backlash against plastic. A good thing for the environment but bad for chemical makers. Demand for plastic is weakening and plastic looks likely to be one of those big sustainability issues.
Industry demand is slowing at a time when China has a number of new plants coming on stream. Demand growth is expected to slow 4% before Chinese manufacturers come onstream. Recycling is pushing demand weaker and initiatives by the EU are only exacerbating the problem for the plastics industry.
Equities: The S&P 500 closed down -0.29% and the Dow fell 0.55%. The Vix closed at 13.91 while the Stoxx Europe 600 Index fell 0.9%.
Currencies: The Bloomberg Dollar index fell 0.5%. The euro rose 0.7% and the pound fell 0.5%.
Bonds: (as at 4.30pm). The ten-year is trading at 2.524%. The 2-year is trading at 2.398% and the 30-year is at 2.97%. The U.S. curve closed on the day with the following closes 2/10 at 12.3bp, 2/30 at 57.1bp and the 10/30 closed at 44.5bp. The U.S. 5-year closed at 2.326%. The 2/5 spread is now -7.4bp. The ten-year bund closed at 0.083% and the British gilt closed at 1.156%. The 10-year yen gilt is trading -0.035%.
Commodities: WTI rose 1.4% and gold rose 0.6%.
Bitcoin is trading around $4,013
Aussie Market Today.
Equities look likely to stage a slight pullback. Asia may help rally stocks. However, as attention is pointed towards the Chinese-U.S. trade deal, any rally will be muted.
Bonds are likely to rally on the day. It’s happy days for the bonds as globally, bonds have rallied, and Australia looks likely to join the party. The currency has bounced on the no-move by the Fed. The Aussie bonds are trading around 1.87% and looking likely to rally further.