Fed paves the ground for predictability


Stable Fed policy through 2020.
Philip Wee, Eugene Leow12 Dec 2019
    Photo credit: AFP Photo


    FX: Fed paves the ground for predictability

    The Fed’s signal to hold rates steady throughout 2020 has brought the USD Index (DXY) lower in its ascending price channel. The DXY could push lower in the short-term if ECB President Christine Lagarde tones down expectations for more rate cuts and monetary easing measures at her first governing meeting tonight. The euro, which is the DXY’s largest component, has closed above 1.11 for the first time since November 4.

    Over the medium term, the Fed is more optimistic about the US economy compared to ECB’s worry over the weakness of the Eurozone economy. Until Ms Lagarde convinces Germany to loosen its fiscal purse, she still needs to assure that the ECB has not exhausted its monetary toolkit. Overall, the relative strength of the US economy and the return of a mild monetary policy divergence in favour of the Fed should limit the downside for the DXY to around 96 and the upside for the EUR to 1.12.

    Similarly, the GBP’s rally in anticipation of a Tory majority at today’s election may end up a “buy the rumour, sell the fact event”. Prime Minister Boris Johnson is only seen “getting Brexit done” on January 31 and not on December 31.  UK’s weak growth, low inflation and higher claimant count continue to point a rate cut by the Bank of England.

    The Fed’s steady rate stance has injected much needed predictability into the highly uncertain global outlook. It would be good if China and the US extend their trade truce into 2020 too. This would require US President Donald Trump to delay the planned tariff increase on December 15. It would be ideal if a Phase 1 deal be achieved with either China accepting the suspension of the above tariffs or the US compromising with some tariff rollbacks. Following which both countries will resume the next round of trade talks after the US elections scheduled for November 2020. The trade war is considered the world’s top risk where expectations of a prolonged war has started to hurt business investment sentiment. Cooling tensions would help the recovery to gain traction. In Emerging Asia, recovery leads to currency appreciation while hurting trade would weaken currencies.

    Rates: Stable Fed policy; keep an eye on USD funding risks        
          
    The FOMC meeting outcome was uneventful. The Fed kept rates unchanged after cutting for three consecutive meetings, in line with consensus and DBS. Market participants were more interested in the dot plot and economic projections (see here). The dot plot signals that the Fed intends to stay on hold in 2020 with dispersion towards a single hike in 2021. Meanwhile, the median forecasts for GDP growth and core PCE inflation remain broadly unchanged from September. The key takeaway is that the Fed will be on pause through the next several quarters, with the hurdle to move (in either direction) set pretty high. In the interest rates space, US Treasury yields fell as the dot plot removes the tail risk of a Fed hike by the end of 2020. Risks of policy moves are still asymmetrical towards cuts in the coming few months.


     
    Meanwhile, year-end USD funding concerns are still simmering despite the Fed’s USD 60bn/mth purchase of T-bills. As noted previously (see Macro Strategy, October 17), ongoing QE-lite will help, but the impact is likely to fall short. Stresses are emerging as the Fed’s term repo operations (that cross the year-end) have been fully subscribed even as overnight rates stay muted. Meanwhile, EUR and JPY 3M bases (versus the USD) has been widening as foreign investors lock in their USD funding needs. Fed Chair Powell indicated that he is open to purchasing other short-term coupon bearing securities, but a move is not imminent. The next quarterly tax repayment (December 17) will be crucial to watch as the seasonal liquidity tightness kicks in and should serve as a dress rehearsal for the year-end. We suspect the short-term USD funding concerns will linger until regulations are tweaked to make repo trades more attractive to the larger banks.

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

     

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com

    The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or finan­cial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.

    DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.

    PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No. 09.03.1.64.96422.