*By Christophe Barraud, Chief Economist & Strategist at Market Securities
According to TrackInsight data, investors kept piling on “Bonds” ETFs with cumulative inflows hitting a new YTD high (>€77Bn). In a context where the U.S. economy is facing risks from trade/geopolitical tensions, weakening business sentiment and a global contraction in both manufacturing and trade growth, the Fed signalled that it has changed its approach from “Data-Dependency” to “Risk-Management”, suggesting that (at least) a quarter-point rate is a done deal at the end of the month.
On Wednesday, in prepared remarks to U.S. lawmakers, Federal Reserve Chair Jerome Powell almost told the bond market that a quarter-point rate cut is a sure thing at the end of the month. Despite a strong rebound in the U.S. job creations in June and the backing of regional Fed presidents like Patrick Harker and Loretta Mester (who had already advocated this month for keeping rates unchanged), Powell seemed to make every effort to note all the possible risks the U.S. economy could face in the short term. The words “uncertainty/ies” and “risk” appeared a combined six times in a very short speech. In addition, looking at price pressures, he underlined that “there is a risk that weak inflation will be even more persistent than we currently anticipate” and added that “inflation pressures remain muted”. That’s an abrupt change of tone compared to latest speeches where weakness in inflation was seen as “transitory”.
Later, June FOMC minutes revealed Fed officials judged uncertainties and downside risks to the outlook for the U.S. economy had increased significantly. The words “uncertainty/ies” and “risk/s” appeared a combined 48 times compared to 36 in the previous minutes. Focusing on the details, “many judged additional monetary policy accommodation would be warranted in the near term should these recent developments prove to be sustained and continue to weigh on the economic outlook’’. Furthermore, “several” policy makers said a near-term rate cut was warranted from a risk-management perspective” because it “could help cushion the effects of possible future adverse shocks to the economy.”
All in all, both Powell’s testimony and FOMC minutes revealed that Fed members changed their approach, shifting from “Data-Dependency” to “Risk-Management” in the short term. The question is now about whether it will be a 25bps or a 50bps rate cut as soon as July. In my opinion, 50bps still looks too much especially in a context where dovish members, including James Bullard, are still cautious. The compromise would be a 25bps insurance cut in July and a tilt toward another one in September. The fact is that based on a new “Risk-Management” approach, it’s clear that uncertainties are unlikely to ease by September given the ongoing trade tensions between U.S./China, U.S./Europe (WTO ruling on Airbus this summer, potential auto tariffs by late November/early December, section 301 into French Digital Services Tax), geopolitical tensions (Iran, North Korea, Russia, Taiwan), U.S. debt ceiling debate, synchronized global slowdown, etc… In this context, other central banks (PBoC, BoJ, ECB) are likely to react later in 3Q19, offering more relief to the bond market in the short term.
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