Insurance cuts supportive of equities; still like USD over EUR
We think the next Fed cut looks like an insurance cut similar to the one in 1995. Back then, the first rate cut came in July 1995 after a 6-month rate pause and after a aggressive one-year rate hike cycle. Concerns that Fed’s rate hikes may be overdone, growth and inflation were both moderating, and the presence of a president seeking a re-election, are some of the parallels between then and now. Fed eventually cut rates thrice back then in between 1995 – 1996. The US market did very well throughout the cycle, from one month before the rate cut to six months after. In Asia, the Hong Kong market, Singapore and the Indonesia market did fairly well. We think that is due to the direct transmission of US rate cuts for Hong Kong and Singapore rates that kept the markets buoyant.
While circumstances under each rate cut is different, as long as rate cuts don’t come too late, we think Asia equities should be well supported. Our preferred markets in Hong Kong, Singapore, Philippines and Indonesia are direct beneficiaries of Fed rate cuts.
FX: Downside risks higher for Europe than the US
The relative strength of the US dollar has been shaken but not shattered by Fed cut expectations. The US 10Y bond yield has held above the Fed’s 2% inflation target. Hence, there is little incentive to pile into the euro where negative EU 10Y bond yields have been falling to new lifetime lows below their Japanese counterparts. The support for the USD Index (DXY) remains intact around 96.5 on the euro’s failed attempts to break above 1.13.
The fragile Eurozone economy is also at risk to a disorderly Brexit. Tory candidates looking to succeed Theresa May as prime minister appeared determined to deliver Brexit on October 31 with or without a deal. Leading Brexiteer Boris Johnson secured the most votes (114 vs a distant second of 43) at the first ballot to select the Conservative Party leader. UK lawmakers earlier voted 309-298 against legislature to block a no-deal Brexit. Having fallen back to last December’s low around 1.26, when Mrs May faced a party leadership challenge, the British pound is at risk extending its fall to its 2016 post-referendum low just above 1.20.
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