- Fed expected to cave to market pressure for a rate cut today
- U.S. and China trade jabs on when a trade agreement might be signed
- Brexit must now wait until after the Dec 12 election
- U.S. Q3 GDP expected to decelerate to +1.6%
- ADP report expected to be weak
Fed expected to cave to market pressure for a rate cut today — The market is discounting a 94% probability that the FOMC at its 2-day meeting that concludes today will cut its funds rate target by -25 bp to 1.50%/1.75%, according to the federal funds futures market.
The Fed has already reluctantly cut its funds rate target twice by a total of -50 bp since July and the Fed is reluctant to cut the funds rate farther given that most Fed officials still believe the economy is in a “good place.” However, the Fed is not brave enough to defy nearly unanimous market expectations for a rate cut since a potentially epic tantrum might otherwise ensue in the U.S. stock and bond markets.
Yet the markets suspect that the Fed’s rate cut this week will be a so-called “hawkish cut” where the Fed indicates that it believes that this rate cut may be the last for this cycle. That cautionary language could be included in the post-meeting statement or expressed by Fed Chair Powell in its post-meeting press conference. The FOMC today is not scheduled to update its now-obsolete Fed-dot forecasts. The last set of Fed dots from September showed a median forecast for no rate cuts through 2020 and then a rate hike in 2021 and a second rate hike in 2022.
Contrary to the Fed’s generally hawkish views, the market is currently expecting at least one more rate cut after today’s cut. Specifically, the market after today’s rate cut is expecting a further 31.5 bp of easing (i.e., 1.3 rate cuts) through the end of 2020. The market is discounting a 38% chance of that additional rate cut at the next FOMC meeting on Dec 10-11, and a 60% chance of that rate cut at the following meeting on Jan 28-29.
The markets today are also awaiting further details on the Fed’s plan to boost its balance sheet by buying $60 billion of T-bills per month, a program that the Fed expects to last at least into Q2-2020. The Fed’s program is designed to boost reserves and alleviate the recent squeeze in liquidity that pushed the repo and funds rate above normal levels. The Fed says that the program is not QE and is only meant to meet the normal banking system demand for reserves. Nevertheless, the added liquidity is bullish for the Treasury market since it should keep the repo rate at lower and more predictable levels and provide more liquidity for the financial system in general.
U.S. and China trade jabs on when a trade agreement might be signed — Chinese officials via a report in the South China Morning Post early Tuesday said that Presidents Trump and Xi are set to sign the phase one trade deal on November 17 at the APEC summit in Santiago, Chile, “if everything goes smoothly.” Trump administration officials later in the day told Reuters that a US-China trade deal might not be ready for signing at the APEC summit but that a delay would not mean that the deal is falling apart.
Tuesday’s exchange suggested that China is trying to add to the pressure on the U.S. to finalize a deal by mid-November, whereas the U.S. seems to be trying to lower public expectations in order to maintain flexibility. The bottom line is that the markets would likely take in stride a short delay of the deal into late November, or perhaps even early December, if President Trump remains optimistic about a deal. However, if a deal takes longer than mid-December and President Trump goes ahead with his plan to impose a 15% tariff on the last $160 billion of Chinese goods effective December 15, then the U.S. stock market would undoubtedly be headed for some significant disappointment.
Brexit must now wait until after the Dec 12 election — The UK Parliament on Tuesday approved a general election for December 12. Prime Minister Johnson said he will not present his Brexit bill to Parliament before the election, meaning that Brexit will now have to wait until a new Parliament is seated. By mutual EU-UK agreement, the Brexit deadline has been postponed until January 31 from Oct 31.
The Conservative Party goes into the election with the polls heavily in its favor. The betting odds are 86% that the Conservatives will win a majority of seats in the next election, versus only 12% for Labour, according to oddschecker.com.
However, there is no guarantee that the Conservatives will win a majority of seats since Nigel Farage’s Brexit Party will siphon off some votes and since anti-Brexit voters will gravitate to Labour or the Liberal Democrats. If the Conservatives win a decisive majority, then they stand a good chance of pushing PM Johnson’s Brexit withdrawal bill through Parliament in January, thus taking the UK out of the EU and ushering in a transition period through the end of 2020. On the other hand, if the Labour Party stages an upset, then Brexit will almost certainly be delayed beyond January 31 as Labour renegotiates the Brexit agreement and possibly holds a public referendum on a final Brexit bill.
U.S. Q3 GDP expected to decelerate to +1.6% — The consensus is for today’s Q3 real GDP report to weaken to +1.6% (q/q annualized) from Q2’s +2.0%, which would be below the Fed’s estimate of +1.9% for the U.S. economy’s long-run growth potential. The slowdown is expected to be caused by continued weakness in business investment and by a deceleration in Q3 personal consumption to +2.6% (q/q annualized) from Q2’s very strong pace of +4.6%. The U.S. economy continues to weaken due to trade tensions, weak overseas growth, and the dissipation of the stimulative effects from the 2018 tax cut.
ADP report expected to be weak — The consensus is for today’s Oct ADP employment report to show a weak increase of +110,000, down from Sep’s +135,000. However, weakness in the report will be partially due to distortions from the GM strike.
