Rates as of 06:15 GMT

Market Recap

The big thing in the market of course was Fed Chair Powell’s semi-annual testimony to Congress. The biggest moves came early on when his prepared statement was released ahead of his appearance. It was generally downbeat, focusing on the problems facing the US economy, often in a “yes, but…” fashion:  the economy is doing well, however inflation is well below target…GDP is growing at a strong pace, however the components of growth are worrisome… You get the picture. He even mentioned the debt ceiling and Brexit. Everything possible that might cause them to ease.  

The key paragraph in that was, “in our June meeting statement, we indicated that, in light of increased uncertainties about the economic outlook and muted inflation pressures, we would closely monitor the implications of incoming information for the economic outlook and would act as appropriate to sustain the expansion. Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened. Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted."

First off, “closely monitor” is Fedspeak for “this is what we will base our decision on.” “Act as appropriate” means “cut interest rates.” “Many” means “a majority.” “Uncertainties…continue to weigh” and “remain muted” means, “we have to do something.”

Later, in the Q&A he delivered more hints that they would cut rates. He said trade uncertainty, global growth, and low inflation were the major issues facing the Fed and put less emphasis on factors that could’ve argued for no hike, such as the positive outcome of the US-China negotiations at the G20 meeting and the strong June jobs report. Asked specifically whether Friday’s good NFP figure changed anything, he replied, “No…the bottom line for me is that the uncertainties around global growth and trade continue to weigh on the outlook. In addition, inflation continues to be muted. And those things are still in place.”

The minutes of the latest FOMC meeting, released afterwards, confirmed Powell’s concern about the downside risks to both growth and inflation.

Before the text was released, the market was pricing in a 5% chance of no cut at the July meeting, a 95% chance of a 25 bps cut and no chance of a 50 bps cut. After the text was released, that shifted to no chance of no cut, an 85% chance of a 25 bps cut and a 15% chance of a 50 bps cut. And during the testimony, the odds of a 25 bps cut in July fell further to 75% while the odds of a 50 bps cut rose to 25%.

The increasing likelihood that rate cuts this year will be deeper than expected should cause the dollar to weaken further, in my view.

One point you might miss from reading the commentary:  while Powell was speaking, the House Democrats were displaying a scrolling list of all of Trump’s criticisms of Powell and Fed policy on three monitors in the committee hearing room.

Powell will repeat his testimony today to the Senate Banking Committee. Occasionally some new pearls of wisdom fall from the Chair’s lips on the second day, but most of the time it’s just a rehash of what he or she said on the first day, so I don’t expect any great revelations.

The Bank of Canada kept rates on hold and reiterated their neutral stance, saying the current policy rate “remains appropriate.” They noted the improving Canadian economy but also mentioned the escalating trade tensions. The market now sees a rate cut this year as a bit more likely that it did before the meeting, but still a low-probability event. I would say this is CAD-positive, as it shows confidence that Canada will not be dragged along with the US. As a result the US-Canada rate spread should widen and CAD is likely to be supported.  

Today’s market

The main – indeed, the only major – indicator out today is the US CPI for June. While that’s not the inflation target that the Fed uses, it plays that role in the public imagination and therefore is closely watched. While the rate of headline inflation is expected to slow, core inflation – excluding food and energy – is forecast to be unchanged at exactly the Fed’s target level (although as I said, this measure isn’t the target). Stable core inflation would give no reason to cut rates and therefore would be positive for the dollar.

In fact, the inflation data isn’t as weak as you might think. Looking at the core CPI – which is more important for policy-makers – the yoy forecast is for its to remain at 2.0%, exactly at the Fed’s target and therefore requiring no change in rates. And the short-term trend would tend to support steady interest rates too – the change from three months ago, annualized, is also expected to be close to 2% yoy. That’s USD positive.

The minutes of the last ECB meeting will be interesting, but they’ve been somewhat superseded by ECB President Draghi’s speech at Sintra, where he said, “Looking forward, the risk outlook remains tilted to the downside, and indicators for the coming quarters point to lingering softness…In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.” That pretty much sums it up. Anything else we learn is simply details, such as how many people agree with him and what they intend to do about it.

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Marshall Gittler

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