Fed Chair Jerome Powell hints at US interest rate cut

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5 June 2019

thomasdodds

The US Dollar has sold-off aggressively across the board so far this week, with comments from Federal Reserve officials causing the market to ramp up bets in favour of a US interest rate cut at some point this year.

F
OMC Chair Jerome Powell stated on Tuesday that the central bank would respond ‘as appropriate’ to recent trade pressures. This followed some even more aggressive rhetoric from fellow Fed member James Bullard, who claimed that lower rates would be ‘warranted soon’. While this is not a clear indication that the bank is preparing to cut rates, it does at the very least suggest that discussions are likely to be had at upcoming FOMC meetings as to whether a lowering of the Fed funds rate is needed.

The 10-year US government bond yield has reacted to Fed dovishness by collapsing around 30 basis points in the past two weeks alone. Financial markets are also now pricing in north of a 90% chance of Fed easing by the end of 2019.

Figure 1: US 10-Year Government Bond Yield (June ‘18 – June ‘19)

We think that a lot now rests on what progress is made in US-China trade discussions. A worsening in the trade outlook could force the Fed’s hand later this year. Regardless, given that the majority of FOMC members (notably messers Williams, Clarida, George and Rosengren) have recently expressed no imminent desire to vote for lower rates, we think that the more than 50% implied probability of a July cut is unwarranted at this stage.

ECB set to strike dovish tone amid downside risks

The next big test for EUR/USD comes in the form of tomorrow’s European Central Bank meeting. Expectations for another dovish message from President Mario Draghi are high given recent soft domestic data and growing external risks.

As we have mentioned in our ECB preview report, we are not expecting any change in forward guidance at this stage, although we are likely to get more details on the recently announced TLTRO programme. The recent focus on the negative impact of ECB stimulus measures on European bank’s profitability suggest that the terms of the programme will be quite favourable. The Euro may instead be driven largely by the ECB’s updated growth and inflation forecasts.

Sterling recovers on Trump’s trade deal comments

Sterling managed to hold its own against most currencies yesterday, taking a breather from the recent Brexit induced battering that has seen it fall to multi-month lows versus the Euro.

Donald Trump’s promise that the US was ready to negotiate a ‘phenomenal’ post-Brexit trade deal with the UK has been behind much of the stabilisation. Yet, with the market still none the wiser as to who will actually be running the country following Theresa May’s imminent departure on Friday, investors are not getting carried away and further weakness in the Pound in the coming days remains likely.