Weekly: Easing race

The decision by the US FOMC to cut the policy rate and end balance sheet runoff two months earlier than envisaged is just the first of several easing measures by major global central banks.
Taimur Baig, Radhika Rao02 Aug 2019
  • ECB is likely to follow soon with deeper negative rates and likely additional QE
  • BOJ will not hesitate to add more stimulus if economic momentum softens
  • Global markets are therefore poised to receive additional liquidity
  • Global economic and financial markets dynamic will continue to favour the US dollar
Photo credit: AFP Photo

Back to policy easing

This week’s decision by the US Federal Reserve’s Open Market Committee to cut the policy rate and end balance sheet runoff two months earlier than envisaged is just the first of several easing measures by major global central banks. Given the signals provided by outgoing President Draghi, the European Central Bank is likely to follow soon with deeper negative rates and additional quantitative easing measures in the coming months. Also, in its latest policy meeting, the Bank of Japan indicated that it will not hesitate to add more stimulus if economic momentum softens

We have therefore reached a transition phase; after a few years of policy normalisation and quantitative tightening, global markets are now poised to receive additional liquidity.

There are two likely ramifications of this shift in stance. First, although economic momentum is faltering in China, Europe, and elsewhere, and trade uncertainties are likely to remain heightened, lower rates and additional QE will support risk assets a tad longer, and possibly extend the economic cycle past 2020. Second, although yield differentials are substantial, the additional liquidity may draw attention back to the USD trend.

One Fed rate cut not enough for markets

From rate hike in December 2018 to rate cut in July 2019, the US Federal Reserve has undergone a remarkable about-turn. After the conclusion of the July 30-31 FOMC meeting, the policy statement and Chair Powell’s press conference suggested the following:

• Global economic weakness (China and Europe) and soft, below-target inflation (core PCE at 1.6%) warrant a “mid-cycle adjustment” rate cut, which downplays the likely magnitude and duration of the rate cut cycle

• Recognising that a further dovish signal is needed, the FOMC decided to conclude the reduction of its aggregate securities holdings (so-called “balance sheet runoff) in August, two months earlier than previously indicated.

• By stating that it is ready to “act as appropriate to sustain the expansion,” the FOMC has left room open for further rate cuts, but the focus on the strength of labour market, retail sales, and overall resiliency of the economy means there is no hurry to cut rates.

• Two Fed members voting against the rate cut, and Chair Powell’s assertion that this is not a protracted cycle were clearly contrary to market expectations, although we found both such aspects of the FOMC meeting outcome rather reasonable.

We have stated for long that the Fed’s dovish tilt can lead to unintended consequences by creating a strong feedback-loop between the markets and the US central bank. By cutting rates at a time of record high employment, frothy asset markets, rebounding consumer sentiment and housing, the Fed has pushed itself into a corner, in our view.

In fact, the markets need not fret much. All that’s needed for another Fed funds rate cut is no resolution in trade wars (quite likely) and listless asset markets for a few months, in our view. Given that the US equity market has rallied by 19% this year (even after the July 31 selloff), a catalyst-starved market that is flat or weak ahead is quite likely, in our view.

The tussle between strong data and poor market sentiment would take a few months. The next rate cut will come in December, in our view. We expect no further rate cuts in 2020, given the proximity to elections, likely trade war truce, and possible firming up of inflation. We will however concede that the outlook is shrouded in uncertainty, and what happens in 2020 is hard to pin down just yet.

We don’t see appreciable curve steepening ahead, unless inflation were to rebound in the coming months. Fiscal slippage and strong growth would be insufficient for inflation expectations to rise, under present circumstances. The long end of the curve will remain supported given the paucity of safe, positive yielding bonds in the G3 space.

The USD will likely remain strong among weak outlook for China and Europe and substantial yield differential in favour of the US. Even if the US treasury were to engage in intervention, there is little near-term downside for the dollar, in our view.

Taimur Baig

To read the full report, click here to Download the PDF.

Taimur Baig, Ph.D.

Chief Economist - G3 & Asia

Radhika Rao

Economist – India, Thailand & Eurozone

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.