- Markets are disappointed that Powell douses hopes for a rate cut
- Markets look ahead to next week’s key US/Chinese trade talks
- Unemployment claims expected to remain favorable
- BOE expected to leave policy unchanged
Markets are disappointed that Powell douses hopes for a rate cut — T-note prices initially rallied on the release of the FOMC’s post-meeting statement because the Fed downgraded its inflation assessment and the Fed also announced a 5 bp cut in the interest on excess reserves (IOER) rate to 2.35%.
Regarding the inflation assessment, the FOMC statement said that both headline and core inflation “have declined and are running below 2%.” That was more dovish than the Fed’s previous language that headline inflation had fallen mainly due to energy prices and that core inflation was near the Fed’s inflation target of 2%.
The markets were not surprised by the Fed’s -5 bp cut in its IOER rate to 2.35% as a technical means to push the funds rate back down towards the middle of the Fed’s 2.25-2.50% funds rate target range. The effective funds rate in the past several weeks has seen upward pressure and rose to 2.45% by Tuesday, which was only 5 bp below the upper 2.50% limit of the Fed’s target range.
By cutting the IOER rate to 2.35%, the Fed is both encouraging the funds rate to drop and is also encouraging banks to lend more reserves in the fed funds market to boost volume and create more of a two-way market. The fed funds market has dried up in the post-crisis era due to the massive supply of excess reserves. While Wednesday’s IOER rate cut was a technical move, it nevertheless represented a Fed move to force short-term rates lower, which was therefore bullish for the Treasury market and bearish for the dollar.
While the initial Fed announcement was bullish, however, T-note prices turned lower after Fed Chair Powell in his press conference said that he doesn’t see a case either way for a Fed rate change. Mr. Powell seemed to be directly telling market participants that they are off base if they are expecting a near-term rate cut. Mt. Powell also disappointed the markets when he said that the recent weakness in the inflation statistics can be traced in part to “transitory” factors, which suggests that the Fed is in no hurry to ease based on a weak inflation outlook.
The federal funds futures curve on Wednesday reacted to the FOMC outcome in a mildly bearish manner. The Dec 2020 federal funds futures market turned more hawkish by 4 bp and is now discounting a -39.5 bp rate cut through 2020 from the 2.35% IOER rate, less than the -43.5 bp cut expected on Tuesday. June 10-year T-note futures prices on Wednesday closed down 3 ticks while the 10-year T-note yield fell by -0.2 bp to 2.500%. The dollar index on Wednesday closed mildly higher by +0.21% on the mildly hawkish outcome of Mr. Powell’s comments. The S&P 500 index on Wednesday closed with a fairly large loss of -0.75%, softened by strength in tech stocks sparked by the +5% rally in Apple on positive late-Tuesday results.
Markets look ahead to next week’s key US/Chinese trade talks — This week’s round of US/Chinese trade talks in China concluded on Wednesday with Treasury Secretary Mnuchin saying that the talks were “productive.” In some good news for the talks, China on Wednesday announced a new measure to open its financial sector by removing limits on ownership of local banks and removing the size requirements of foreign firms that operate in China.
The market is now looking ahead to next week’s key US/Chinese trade talks in Washington. FT on Tuesday reported that next week’s US/Chinese meetings will be much more substantial than this week’s meetings. Chinese Vice Chair Liu will arrive this Sunday in Washington with as many as 100 Chinese officials in tow for five or six days of talks. The goal will be to have a final agreement by the end of next week and a date for a Trump-Xi signing summit in late May or early June.
If there is a US/Chinese trade agreement, reaction in the markets will depend in large part on the amount of penalty tariffs that are left in place after the agreement. The markets would be very pleased if all the tariffs are removed immediately. However, President Trump has suggested that the first batch of tariffs on $50 billion of Chinese goods will remain in place to help enforce the agreement. In that case, the markets will be watching to see if China accedes to the U.S. request that China’s retaliatory tariffs on U.S. agricultural products be shifted to other products. If China instead leaves in place retaliatory tariffs on U.S. agricultural products, then President Trump will have a difficult time pitching his trade deal to U.S. agriculture producers as a win.
Unemployment claims expected to remain favorable — The consensus is for today’s weekly initial unemployment claims report to show a -15,000 decline to 215,000, giving back part of last week’s +37,000 rise to 230,000. Continuing claims are expected to show a +5,000 increase to 1.660 million after last week’s +1,000 increase to 1.655 million. The unemployment claims data remains in very favorable shape. The initial claims series is only +37,000 above the 50-year low of 193,000 posted in the April 12 week and the continuing claims series is only +6,000 above the 45-year low of 1.649 million posted in October 2018.
BOE expected to leave policy unchanged — The Bank of England at its meeting today is expected to leave its policy unchanged with the base rate at 0.75%, where it has been since last August. This is the first BOE meeting since the Brexit deadline was extended all the way out to October 31. However, the BOE has little choice but to keep policy unchanged due to the high uncertainty about where Brexit is headed and where the UK’s politics are headed. PM May might miraculously pull of a compromise that gets Parliament to approve the withdrawal bill and the UK be will out of the EU in short order. More likely, however, the process will drag on for months with the outside possibility of a snap election.
