Fed will play up policy flexibility; USD underpinned by G3 monetary outlook

Forward guidance from the Fed will be closely watched.
Eugene Leow, Philip Wee17 Jun 2019
    Photo credit: AFP Photo

    Rates: Fed will play up policy flexibility   

    The FOMC convenes this week (18-19 June). The perception gap between the Fed (the March dot plot signals a hike in 2020) and the market (four cuts by end-2020) is large. The last time this occurred in late 2019/early 2019, the Fed capitulated into a pause. With equities resilient through this episode of lower US yields and US data not showing clear signs of weakness, it is difficult to justify looser monetary policy on fundamental or financial conditions arguments. The only conceivable way would be to highlight downside risks due to prolonged China-US trade tensions. Unfortunately, there is lack of clarity on this front and it is uncertain if anything can be resolved at the G20 meeting later this month.

    The more interesting aspect lies with the dot plot. Since it was introduced 2012, the dot plot has always pointed to increasing rates over the coming few years. However, the rate normalisation cycle is done and market participants would want to see how serious the Fed is on rate cuts. Consensus does not expect the Fed to cut at the upcoming meeting and if the Fed indicates cuts in the dot plot, it would beg the “why wait?” question. Conversely, if the Fed signals no cuts, that could risk alienation with market participants and result in an adverse financial market reaction. One workaround might be to leave policy contingent on how events play out acknowledge considerable uncertainties on the timing and magnitude of rate cuts. Flexibility on policy and a willingness to take out insurance cuts (if needed) might be the best way to view the Fed right now.        

    FX: USD underpinned by G3 monetary outlook

    The US dollar index (DXY) has recovered 60% of the past weeks’ losses into the FOMC meeting on June 19. The Fed Funds Rate is set to be unchanged at 2.25-2.50%. The Fed is likely to refrain from omitting the word “patient” from its FOMC statement and hold back signaling a cut at the following meeting on July 31. The S&P 500 index has recovered almost three-quarters of May’s sell-off. The Fed will want to sit out next week’s G20 Summit to assess the trade tensions between China and the US.
    The Fed takes the view that the US economy is sound but not immune to global risks. Hence, it does not make sense for US “insurance cuts” to come before the Eurozone and Japan where growth rates were notably weaker. Instead, the surprises could come from ECB President Draghi‘s speech at the ECB Forum in Sintra on June 18 and the Bank of Japan’s meeting on June 20. For now, G3 government bond yields better explain why the USD has surprised on the upside. The US 10Y bond yield found support above the Fed’s 2% inflation target while those in Eurozone and Japan have continued to plummet new lows below 0%.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Philip Wee

    FX Strategist - G3 & Asia

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