There once was a banker named Jay
Who lived deep inside the Beltway
His words, when he spoke
Would sometimes evoke
A dovish response on the day
 
On Monday, we all got to hear
His views, and to some he was clear
Quite soon he’ll cut rates
Thus, ending debates
‘Bout ‘flation the rest of the year

 

While the market awaits this morning’s Retail Sales data (exp 0.0%, 0.1% ex autos), the focus for most traders and investors has been on Chairman Powell’s speech and discussion yesterday at the Economic Club of Washington DC.  The following headlines came from his prepared remarks and were highlighted all over the tape:

*POWELL: LAST THREE INFLATION READINGS DO ADD TO CONFIDENCE 

*POWELL: LABOR MARKET ESSENTIALLY NO TIGHTER THAN PRE-PANDEMIC 

*POWELL: JOB MARKET DOESN’T HAVE SLACK, ESSENTIALLY EQUILIBRIUM 

Then, following up in a Q&A, the money lines were these, “Now that inflation has come down and the labor market has indeed cooled off, we’re going to be looking at both mandates.  They’re in much better balance.”  

Not surprisingly, the market took this as confirmation that rate cuts are coming soon, although the futures market continues to price September as the likely first move.  While the meeting in 2 weeks has only a 9% probability priced in for a 25bp cut, looking at September’s pricing, 25bps are guaranteed and there are now some traders/investors looking for a 50bp cut, with that probability at 12.5%.  

Personally, I think there is a better chance of a July cut, especially if the PCE data next week are as soft as the CPI data were last week, than a 50bp cut in September.  My sense is that to get 50bps in September we would need to see the Unemployment Rate rise to 4.7% by that meeting with NFP pushing toward zero.  And while anything is possible, that seems highly unlikely in terms of the speed of the adjustment for those economic data series.  Other than the pandemic, even during deep recessions in the past, the rate didn’t rise that quickly.

As such, the market is now quite comfortable with the idea that the long-awaited initial rate cut will be here before the Autumnal equinox.  So, if that is the case, what does it mean?

One cannot be surprised that equity markets remain buoyant as we continue along the goldilocks trail of solid growth with slowing inflation.  Cutting rates into this environment will just add fuel to the equity fire.  There has been much made in financial discussions about the recent performance of small-cap stocks during the past several sessions.  It seems they have finally awoken from their deep slumber and have performed quite well, better even than the mega-cap tech names.  This has generated great excitement and we have seen several analysts raise their equity forecasts ever higher.  It seems that S&P 500 at 6000 is now a conservative view!

In the Treasury market, the yield curve has been slowly reverting to its more normal shape with 2-year yields falling more rapidly than 10-year yields.  This is the bull steepening that many had been anticipating, where yields overall decline, it’s just that the front end of the curve falls faster than the back.  History has shown that this type of movement typically foreshadows a recession, as the steepening accelerates when the Fed is slashing rates as the economy heads into a tailspin.  But maybe this time is different.  Ultimately, it can be no surprise that the yield curve is moving back to its normal shape of long-term yields higher than short-term yields.  After all, this inversion has been the longest in history.  I am just concerned that the speed of the onset of the coming recession may be much faster than most people assume.

As to commodity markets and the dollar, if the Fed is moving into a policy easing cycle, then commodity prices, especially precious metals and energy, ought to rally from here.  There may be a delay in industrial metals as a weak economy will weigh on demand there.  And the dollar will likely have a considerable down leg as well, although it will be tempered as central banks elsewhere around the world feel emboldened to be more aggressive with their own policy easing.

So, with that as a framework ahead of any potential future Fed actions, let’s look at what happened in the immediate wake of the Powell comments.  (As an aside, SF Fed President Daly also spoke yesterday and reiterated her concerns over the rise in the Unemployment Rate, indicating she was ready to cut.  Too, Chicago Fed president Goolsbee explained he was on the same page.)

Of course, given the Powell commentary, it is no surprise that US equity markets rallied yesterday with a new record high close from the DJIA although neither the NASDAQ nor S&P 500 could hold their record highs into the close.  Nonetheless, it was a strong day in the US markets.  In Asia, though, the picture was more mixed with the Nikkei (+0.2%) edging higher alongside a small move higher in USDJPY, and mainland Chinese shares (CSI 300 +0.6%) also gaining on hopes for some positivity from the Third Plenum.  But the Hang Seng (-1.6%) fell on fears of a Trump victory and the imposition of more tariffs on goods from there. The rest of the APAC space saw mixed reviews with some gainers (Taiwan, New Zealand, Korea) and some laggards (Australia, Malaysia, Singapore) although most of this movement was in small increments, 0.25%-0.35%.

European bourses, though, are having a tougher day as they are all lower on the session.  It seems that concerns over a Trump victory are manifesting themselves in concerns over European sales into the US or the imposition of tariffs here as well.  Adding to the misery, German ZEW data revealed a turn back down after several positive months, as concerns over the political situation in France and declining exports there weighed on the reading.  The upshot is that there is weakness everywhere, led by the CAC (-0.8%) in Paris and the IBEX (-0.8%) in Madrid.  (I think I wrote that exact sentence yesterday!). In the end, after a nice run as investors started to bet on ECB rate cuts, that story seems to be diminishing.  As to US futures, at this hour (7:30) they are modestly firmer, 0.2% or so.

In the bond market this morning, it appears that everyone around the world is excited about the possibility of Fed rate cuts as yields are lower across the board.  Treasury yields are down 6bps and European sovereign yields have fallen between 3bps and 5bps.  Even JGB yields slid 3bps overnight.  As has been the case for quite a while, the US yield story leads the global yield story.  If the Fed is going to start to cut, I expect that yields around the world are going to decline further, at least until inflation returns.

In the commodity markets, oil (-1.6%) is under pressure after weak oil demand data from China overnight undermined hopes that the Third Plenum would result in more government stimulus from the Xi government. This weakness is evident in industrial metals as well with both Cu (-0.65%) and Al (-1.0%) sliding further. However, precious metals are responding as one would expect to rate cuts, especially with inflation still around, as both gold and silver higher by 0.7% this morning, taking gold to new all-time highs.

Finally, the dollar continues to range trade overall with the DXY little changed on the day and hanging out just above 104, which happens to be its 60-year average!  While most currencies in both the G10 and EMG blocs are within +/-0.2% of yesterday’s closes, the one outlier is ZAR (+0.8%), which seems to be responding to some domestic plans to increase infrastructure investment in conjunction with private companies.

Other than the Retail Sales data mentioned above, there is nothing of note on the calendar today, although we will hear from new Fed governor Adriana Kugler.  At this point, I think it is becoming clear that the entire FOMC is on the same page; higher for longer is dead, long live the beginning of policy ease.  It is setting up to be a quiet session although I expect to see continues support for rate sensitive products like equities and precious metals.  The dollar, though, seems stuck as every central bank is ready to cut!

Good luck

Adf