There is a big divide over the size of Fed cuts

Investors are grappling with the Fed’s priorities as it turns to pre-emptive action to avert a slump
Chief Investment Office19 Jul 2019
Photo credit: AFP Photo


The relative steadiness of market pricing for 2019 Federal Reserve rate cuts over the past month may look like conviction, but it is hiding a major divergence in investors’ views and potentially a window of opportunity.

Fed funds futures indicate about 80 bps of easing by the end of the year. While that is up a bit from where things stood at the beginning of June, it does not necessarily indicate traders see three standard quarter-point cuts as a lock. The odds of more aggressive action this year have been swinging around a lot over recent weeks, and the latest moves are in favour.

A mixed bag of US corporate earnings has pushed stocks lower over the past few days and buoyed Treasuries, driving benchmark 10-year yields back down toward 2%. A burst of activity Thursday (18 July) shifted the odds in favour of a half-point cut this month rather than the quarter-point considered most likely until now.

The path of rates for the rest of this year also remains a moving target, as over recent weeks the market-implied probability of 50 or 100 bps of cuts by December has swung sharply. The latest moves have seen bets on aggressive action overtake the more moderate camp.

The latest action in euro-dollar futures and options points to wagers both ways. On Wednesday, some traders staked out new short positions in December 2019 euro-dollar contracts, suggesting a bet on less easing than is currently priced. Opposing positions are still in play, judging by open interest data and information from traders close to the action.

Investors are grappling with the Fed’s priorities as it turns to pre-emptive action to avert a slump, even as the jobless rate remains close to a 50-year low. – Bloomberg News.

The S&P 500 Index rebounded 0.36% to 2,995.11 on Thursday (18 July), the Dow Jones Industrial Average climbed 0.01% to 27,222.97, and the Nasdaq Composite Index jumped 0.27% to 8,207.24.



European Central Bank (ECB) staff have begun studying a potential revamp of their inflation goal, according to officials familiar with the matter, in a move that could embolden policymakers to pursue monetary stimulus for longer.

The staff are informally analysing the institution’s policy approach, including the question of whether the current target of consumer price growth “below, but close to, 2%” is still appropriate for the post-crisis era.

President Mario Draghi favours a “symmetrical” approach, meaning flexibility to be either above or below a specific 2% goal, the officials said, asking not to be identified as the work so far is confidential and preliminary. That would allow the ECB to keep inflation elevated for a while after a period of weakness to ensure price growth is entrenched.

Governing Council members were given a presentation by Massimo Rostagno, the ECB’s director general for monetary policy, on the effectiveness of the current target, according to one of the officials. Rostagno showed that a straightforward 2% objective would make it easier to raise inflation and price expectations, and reduce the need to push interest rates deeper below zero in the future.

Bonds and stocks jumped on the report. The euro slid to its lowest of the day at USD1.1205. It was little changed at USD1.1217 at 3:21 pm Frankfurt time. – Bloomberg News.

The Stoxx Europe 600 Index dropped 0.22% to 386.80 on Thursday (18 July).



Japan’s key inflation gauge fell again in June, adding to pressure on the Bank of Japan (BOJ) to join its global peers in increasing monetary stimulus.

Consumer prices excluding fresh food rose by 0.6% in June from a year earlier, which matched economists’ median estimate, data from the internal affairs ministry showed Friday (19 July). That was the lowest reading since July 2017.

Slowing inflation adds pressure on the BOJ to step up its stimulus, especially with the Federal Reserve widely expected to start cutting rates later this month. The problem is the BOJ’s arsenal is largely depleted.

Lower mobile phone service charges and free preschool education are among factors expected to drag inflation lower in coming months. The Fed’s dovish turn has also helped strengthen the yen, weakening inflationary pressures via lower import costs.

A sales tax increase slated for October is also a worry for policymakers. Previous increases have hit consumers hard, sending the economy reeling. – Bloomberg News.

Japan’s Nikkei 225 Index rebounded 0.55% to 21,161.19 on Friday (19 July) morning. It tumbled 1.97% to 21,046.24 in the previous session.

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