Market Thoughts – Thursday 19th September – The Morning After The Night Before

Where We Stand – The dust continues to settle on the FOMC’s ‘jumbo’ 50bp cut this morning, albeit with such a reduction having been framed as a ‘recalibration’ in policy, rather than a sign of things to come, particularly with the ‘dot plot’ pointing to 25bp cuts at each of the final two meetings this year. A “hawkish 50bp cut”, anyone?

In any case, stocks have lurched higher overnight, with ‘green on the screen’ across the globe, as buyers come to the fore once more, with both the S&P 500 and Nasdaq 100 futures gaining well over 1% at the time of writing. The path of least resistance continues to lead to the upside.

Despite Chair Powell being at pains to stress that participants should not consider 50bp cuts the norm from here on in, the USD OIS curve has priced an aggressively more dovish outlook, seeing around 70bp of further easing by year-end, almost an entire rate cut more than the dots signalled. Reining in market expectations could well be the first task for Fed speakers, when the blackout period ends.

Another point that was interesting from yesterday’s FOMC is the faith that policymakers have in their economic forecasts. With inflation still above target, unemployment at 4.2% (and having fallen in August), plus the economy having grown by more than 2% in seven of the last eight quarters, there is little at face value to suggest the need for such a sizeable rate cut. Instead, the move to deliver such a cut was seemingly driven by the 0.4pp upward revision to this year’s unemployment forecast, and 0.2pp downward revision to the core PCE projection.

If you think the Fed’s forecasts are right, you’ll think 50bp was justified. If you think them too gloomy, as I do, you’ll think 50bp was over-the-top. Either way, most folk will be hoping that this is not a repeat of the last two times the FOMC kicked-off an easing cycle with a 50bp move – 2007, and 2001, are not years that many look back on fondly.

For markets, yesterday’s FOMC was a rollercoaster ride, with the knee-jerk equity & Treasury demand, plus USD weakness, on the decision itself fading rather rapidly. The greenback ended higher, with the DXY reclaiming the 101 handle, consolidating there overnight, as all G10s gave up earlier gains. This included a rather rapid retracement in cable from a 2-and-a-half year high just shy of 1.33. If you’d told me, this time yesterday, that the buck would end the day in the green after a 50bp cut, I probably wouldn’t have believed you.

In any case, yesterday’s decision doesn’t feel like a game-changer from a broader perspective. The forceful Fed put remains in place, with policymakers clearly willing and able to move quickly with rate cuts were the economy to roll over further. At the same time, there was relatively little clarity on the pace at which rates will return to a neutral level, giving FX and FI operators relatively little to go off.

The issue here, for policymakers and market participants alike, is that while the direction of travel – i.e., rate cuts – may be clear, the speed of the journey, and the destination to which we are travelling, are both unknown!!

Crudely, though, Powell & Co.’s reaction function for now seems to be that 25bp cuts will come, at every meeting in the short-term, unless data – particularly jobs figures – softens beyond expectations, at which point 50bp moves are in the frame once again.

Look Ahead – Another busy day of policy decisions awaits, though today’s events should be somewhat more straightforward to navigate.

The ‘Old Lady of Threadneedle Street’ highlights proceedings, with the BoE’s MPC set to keep Bank Rate unchanged at 5% this lunchtime, having delivered this cycle’s first rate cut back in August. Then, in a 5-4 vote, the MPC set a relatively high bar to further easing, with a cut off the table this time around, particularly considering yesterday’s rise in both core and services CPI, to 3.6% YoY and 5.6% YoY respectively.

My base case is for an 8-1 MPC vote in favour of holding Bank Rate steady, with just external member Dhingra dissenting in favour of back-to-back cuts, though there is a chance that either, or both, Deputy Governor Ramsden, and new external member Taylor, join her in this dovish camp. Either way, the policy statement should be a ‘copy and paste’ of that issued las time out, signalling a slow and steady approach to removing policy restriction.

The BoE’s latest decision on quantiatitve tightening is also due. At a minimum, despite surging repo usage and signs of a funding squeeze beginning to emerge, I’d expect the annual pace of balance sheet run-off to remain at £100bln, if only to account for the sharp rise in gilt redemptions next year, which would see the pace of active sales drop below £15bln if the overall QT pace were maintained. There is, hence, a case to quicken the overall pace of run-off, though I doubt the MPC go down this route, particularly given the difficulties that policymakers would have in communicating easing conditions via Bank Rate cuts, while simultaneously tightening them via quicker balance sheet run-off.

Away from the BoE, the Norges Bank are also set to decide policy today, though few fireworks are expected, with rates set to remain at 4.50%. Of interest will be whether the NB signal the potential for cuts this year, having previously not pencilled in a rate reduction until 2025. The NOK OIS curve fully prices just one 25bp cut by year-end, hence markets shouldn’t be too surprised by any potentially dovish rhetoric.

Elsewhere, today, the weekly US jobless claims report is worth a cursory glance, if only due to the initial claims print coinciding with the survey week for the September payrolls report. Existing home sales, and the Philly Fed’s manufacturing survey, are also both due, though unlikely to significantly move the needle. The same can be said for remarks from the ECB’s Schnabel, Nagel, Panetta and Knot through the day, which are Knot likely to provide much new information (sorry!).