Said Jay, there are two goals we seek
Strong job growth while prices are weak
And as I sit here
The way things appear
Come autumn, Fed funds we may tweak

The market responded with glee
Twas truly a stock jamboree
Plus, bonds joined the fun
And went on a run
The dollar, though, sank in the sea

At this point, the only question in market participants’ minds is whether the Fed will cut 25bps or 50bps in the September meeting.  Yesterday afternoon, as widely expected, the FOMC left rates unchanged and tried to offer a balanced view of the future, explaining that both of their dual mandate goals were normalizing.  Obviously, inflation, which has been their primary focus for the past two years, has been moving in the right direction and Chairman Powell reiterated that they are gaining ‘confidence’ that they will achieve their 2% target.  But this time, Powell spent more time describing the job market and how it was now coming into balance.  In other words, what had previously been a significant inflationary pressure in the Fed’s collective view, was now having less of an impact on prices.

At the press conference, Powell would not be pinned down on a September cut, although based on pricing in the Fed funds futures market, you would be hard pressed to believe that.  This morning, the market is pricing more than 28bps of rate cuts (a 13.5% probability of a 50bp cut) into the September meeting, so the key will be to watch how that probability of a 50bp cut evolves.  If we start to see hard data, like tomorrow’s NFP or CPI, in two weeks’ time, decline, I’m confident that the market will be calling for a 50bp cut before long.

In the end, the recent correction seen in risk asset markets seems to have been just that, a correction, and now the narrative is that there are blue skies ahead with lower rates to support things and the Fed is going to stick the soft landing.  This poet is less certain that the best case will obtain, but that’s what makes markets.

So, even though we have not yet heard from the third major central bank as I write (the BOE is due to announce in a few hours’ time), I don’t think that is going to impact the global narrative.  Let me start by saying that I believe they will cut rates in the UK as yesterday’s activities in the US make it all but certain a cut is coming here, and given the ECB, BOC and Riksbank have all cut already, they have plenty of company.  However, let’s recap where things are now and what the market narrative is now explaining to us all.

Policy normalization is the new watchword as we hear that the BOJ is normalizing policy by raising interest rates and tightening while the rest of the G10 are normalizing policy by cutting rates and ending activities like QT.  I guess the definition that the punditry ascribes to normal policy is, every country has the same interest rate!  In fact, I say that only half tongue in cheek, as there is some merit to the discussion.  While it is certainly true that global economies have evolved in greater synchronicity over the past decades, interest rate policy has always been based on the idiosyncrasies of each economic area.  For instance, money supplies and productive capacities differ widely amongst countries, so why should we believe that the “proper” monetary policy is the same level of interest rates across the board.  Of course, we shouldn’t, but for market participants, it is much easier if they have one target for everything rather than being forced to understand each economy in its own right.

But with that in mind, let’s recap where things currently stand around the major economies.

1.     US – economic activity is slowing, but the pace of that slowdown is very modest, at least based on the recent GDP reading.  Inflation is slowly receding but has not yet achieved the Fed’s target and the jobs market has, to date, held up reasonably well.  Of course, we will know more about that tomorrow.  On the flip side, the manufacturing portion of the economy has been the laggard, with PMI and regional Fed surveys pointing to subpar activity.  There seems to be a disconnect between the slowing economy and the roaring equity market, but markets have a life of their own.
2.     Europe – economic activity overall is modest with a reversal in the weak vs. strong players as Germany is the sick man of Europe and the PIGS economies are all faring far better.  Inflation here is a bit stickier than it seems in the US as evidenced by yesterday’s higher than expected readings and remains well above the 2% target here.  Most nations are seeing more substantial weakness in their manufacturing sectors, although for some (I’m looking at you Germany) it is self-inflicted based on insane energy policies driving energy costs much higher.
3.     Japan – recent growth signs have been quite poor with a negative GDP release just last week indicating things are not going well.  This has been accompanied by above target inflation, which while seeming to slow, is slowing very gradually.  In fact, this is the one place where the FX rate seems to really have had an impact, with the yen’s previous weakness adding to inflationary pressures and offsetting their very modest monetary policy tightening.  However, the combination of the BOJ hiking and the Fed seeming to promise a cut has led the yen to recoup nearly 8% over the past several weeks and now that USDJPY is below 150, I expect to see this move continue.  That should help ameliorate some of the inflation pressures, although it is not clear to me it will help economic growth.
4.     China – last night’s Caixin Manufacturing PMI was a disappointing 49.8, down two points and below expectations.  The indication is that economic activity in China remains hampered by the lack of consumer activity.  China’s long-term policy of mercantilism is running into its limits as nations around the world are unwilling to take their excess production freely, and the domestic economy remains in the doldrums, still suffering from the ongoing deflation of the property bubble.  While the PBOC did reduce interest rates recently, the fact that neither the Third Plenum nor the Politburo were willing to inject real stimulus into the economy indicates that things are going to remain lackluster going forward.

Arguably, the lesson from this recap is that economic activity is in a downtrend and that inflation is also in a downtrend, just a shallower one.  Policy makers around the world are struggling to find the right mix because oftentimes, the right mix means something politically difficult.  Net, I expect this process will continue and that we will see more and more efforts to turn around the economic trend while ignoring the inflation trend.

Ok, this has turned into more than I expected, so let’s be quick on markets today.  Yesterday’s Fed led to a huge tech sector rally in the US but that was not enough to help the rest of the world.  Despite that optimism, Japanese shares (-2.5%) were down sharply on the continued strength of the yen, while Chinese shares, in both Hong Kong (-0.25%) and the mainland (-0.7%) saw no love either.  In fact, the whole region was under water.  The same is true in Europe this morning with all the continental bourses lower on average by -0.65% or so after continued weak PMI data was released this morning.  The only exception here is the UK, where the FTSE 100 is now higher by 0.3% after the BOE, as I expected, cut rates by 25bps at 7:00am.  As to US futures, euphoria is still alive and they are all higher at this hour, just past 7:00.

In the bond market, yields are declining around the world led by Treasury yields which fell 10bps yesterday, although they have rebounded by 2bps this morning.  2yr yields also fell a similar amount so the yield curve’s inversion remains at -23bps this morning.  In Europe, yields also slid yesterday, albeit not as much as in the US and are a further 2bps lower this morning as they try to catch up.  The exception here is the UK, again, as 10yr Gilt yields are lower by 5bps this morning in the wake of the BOE cut.  JGB yields overnight fell 1bp, although given the move in Treasury yields, that gap has still narrowed substantially.

In the commodity markets, oil (+0.9%) continues to rally as fears over an Iranian retaliation against Israel grow with no clear idea where this will stop.  Consider, though, WTI remains below $80/bbl still, so right in the middle of its longer term range.  I imagine we could see a bump higher, but remember, OPEC has a lot of spare capacity, so if some countries are forced to stop producing, the Saudis can turn on the taps.  Gold (-0.4%) is backing off the new all-time highs it reached yesterday, but remains far above $2400/oz.  In fact, all the metals markets saw gains yesterday and this morning they are ceding some of those gains, but I don’t think this story has changed; if the Fed gets more aggressive, I expect these commodity prices to rise further.

Finally, the dollar is on fire this morning, rallying against everything but the Swiss franc right now.  The pound (-0.7%) is under the most pressure in the G10 after the rate cut, but we are seeing weakness everywhere else but Norway and Switzerland.  Even the yen, which had broken through the 150 level earlier this morning is now back below (dollar above) that level, although I expect there are further declines to come here in the dollar.  One other surprisingly large mover is CNY (-0.4%) which has given back more than half its gains from the activities last week involving the PBOC rate cuts and intervention.  Remember, if the yen continues to strengthen, the renminbi will be able to do so at a very gradual rate and maintain increased competitiveness vs. Japanese exports.

On the data front, this morning brings Initial (exp 236K) and Continuing (1860K) Claims, Nonfarm Productivity (1.7%), Unit Labor Costs (1.8%) and ISM Manufacturing (48.8).  Remarkably, there are no Fed speakers on the schedule, but I imagine they will not be able to keep quiet for long.  However, while there is a definite glow amongst investors, all eyes will turn to tomorrow’s NFP data, where a hot number will not be taken well, at least not at first, but if we print below NFP expectations, look for stocks to rock on a growing expectation of 50bps in September.  That will also hurt the dollar, which should retrace some of today’s gains.

Good luck
Adf