- U.S. markets are now far more dovish than Fed with expectations for at least two rate cuts through 2020
- U.S. trade deficit expected to narrow mildly from Dec’s 10-year high
- U.S. Q4 current account deficit expected to widen to new 10-year high
- 5-year T-note auction
- Today’s Brexit indicative votes may shine some light on how Brexit can move forward
U.S. markets are now far more dovish than Fed with expectations for at least two rate cuts through 2020 — The market consensus for Fed policy has turned dramatically more dovish since last week’s FOMC meeting. The markets were encouraged that the FOMC at last week’s meeting reaffirmed its neutral policy by cutting the Fed-dot forecast to zero rate hikes in 2019 from December’s forecast of two rate hikes. However, the Fed dots still left in place a forecast for one rate hike for 2020.
The market took the Fed’s dovish signals last week as a sign to accelerate rate hike expectations. The Dec 2019 federal funds futures contract since last week’s FOMC meeting has fallen sharply by -17 bp to 2.17%, reflecting a 92% chance of a -25 bp rate cut by year-end from the current level of 2.40%. The Dec 2020 fed funds contract plunged by -33 bp to 1.815%, reflecting expectations for a total of 2.3 rate cuts by the end of 2020.
U.S. trade deficit expected to narrow mildly from Dec’s 10-year high — The consensus is for today’s Jan U.S. trade deficit to narrow mildly to -$57.0 billion from December’s 10-year high of -$59.8 billion. The wider U.S. trade deficit has been caused mainly by a slide in U.S. exports, which have fallen in 6 of the last 7 months and were up by only +0.1% y/y in December, representing a major deterioration from growth of +10.4% y/y seen as recently as a year ago in May 2018. U.S. exports have been hurt by (1) the raft of retaliatory tariffs that have been slapped on U.S. exports, and (2) weaker overseas economic growth.
Meanwhile, U.S. imports have been stronger than exports in recent months, leading to the wider trade deficit. Import growth in December of +3.1% y/y was stronger than export growth of +0.1% y/y. However, imports have also weakened in recent months and have shown little net growth in the past four months. U.S. imports have been hurt by the tariffs that the Trump administration has placed on solar equipment, washing machines, steel, aluminum, and $250 billion of Chinese products.
U.S. Q4 current account deficit expected to widen to new 10-year high — The market consensus is for today’s Q4 U.S. current account deficit to expand to a new 10-year high of -$130.0 billion from the current 10-year high posted in Q3 of -$124.8 billion. The U.S. current account deficit is expected to widen due to weakness in exports caused by weaker overseas economic growth and by retaliatory tariffs on U.S. exports.
The widening U.S. current account deficit is an underlying long-term bearish factor for the dollar. The deficit means that a net $1.4 billion worth of dollars are flowing out of the U.S. every day to finance U.S. trade imbalance. That outflow is bearish to the extent that recipients of those trade dollars do not wish to hold those dollars in dollar-denominated investments and therefore sell those dollars in the global FX markets.
5-year T-note auction — The Treasury today will sell $18 billion of 2-year floating-rate notes and $41 billion of 5-year T-notes. The Treasury will then conclude this week’s $131 billion T-note package by selling $32 billion of 7-year T-notes on Thursday. Demand for yesterday’s 2-year T-note auction was respectable, particularly considering the recent sharp decline in yields. There was strong demand from foreign buyers with indirect bidders taking 56.0% of the auction, well above the 12-auction average of 44.3%.
The 5-year T-note yield on Tuesday rebounded higher to 2.20% from Monday’s 15-month low of 2.16%
The 12-auction averages for the 5-year are as follows: 2.44 bid cover ratio, $44 million in non-competitive bids, 3.8 bp tail to the median yield, 17.5 bp tail to the low yield, and 58% taken at the high yield. The 5-year T-note is mildly below average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 60.3% of the last twelve 5-year T-note auctions, which is mildly below the median of 61.3% for all recent Treasury coupon auctions.
Today’s Brexit indicative votes may shine some light on how Brexit can move forward — The UK Parliament today will hold a series of non-binding indicative votes on a range of Brexit Plan B options such as a second public vote, staying in the EU’s customs union, or canceling Brexit altogether. Today’s voting might provide a better idea of what the UK Parliament could conceivably agree upon down the road, as opposed to only knowing at this point what Parliament doesn’t like.
Meanwhile, Prime Minister May on Tuesday received a small break after Brexit hardliner and Conservative MP Rees-Mogg said he would support Ms. May’s Brexit separation agreement since the alternative might be no Brexit at all. Government officials said that Ms. May might hold a third vote on her Brexit separation agreement on Thursday if she thinks she can get enough support in Parliament to pass the bill. However, that still looks doubtful since Northern Ireland’s DUP party said yesterday that it still opposes the bill and instead now favors a long deadline extension.
If a Brexit separation agreement is approved by the new deadline of April 12, then the deadline would be extended until May 22 to give Parliament time to pass the enabling legislation. By contrast, if Parliament does not approve a Brexit separation agreement by April 12, then the UK faces either a no-deal ejection from the EU on April 12 or the need to request what will likely be a long Brexit deadline extension.
The strongest odds at present continue to favor a long extension. Today’s Parliament voting will indicate the extent of support for a softer Brexit and/or a second public referendum, which could take form during the extension period.
