It's hard not to focus on the communication faux-pas from the New York Fed, but it seems too important to avoid. I flagged NY Fed president, John Williams, speech in yesterday’s ‘Daily Fix’ as a potential volatility event, suggesting the risk of guiding the market to 50bp was a low probability; but it was a risk.
In hindsight, I was incorrect because when we heard Williams (NYSE:WMB) speech, there was little doubt it gave us the impression that a 50bp cut was on the cards. The Fed acting “aggressive” in setting policy for more worrying outlook sounds like 50bp. As do comments that "it’s better to take preventative measures than to wait for disaster to unfold. When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress”.
I guess it’s hard to hear these words, knowing that there is a blackout period from next week and not feel they were designed to guide the market to that the Fed had to do something big on 31 July.
The fact, then, that the comments promoted a broad USD sell-off, largely driven by a move in rates, pricing the chance of a 50bp cut from 33% to 67%, with equities and gold following closely, and this feels like it was the right reaction. We saw economists alter their base-case for Fed action to 50bp, another sign behind the conviction Williams words were a key signal.
The NY Fed's message to the market - calm the farm
What happened in the early Asia session has been all the talk on the floors this morning, with the NY Fed putting out a statement that John Williams words were aimed at an academic level, and not a cat-out-bag type policy guidance on behalf of the broader Federal Reserve. This seems incredibly important, and aside from calls that the Fed should be more in-tune with markets, there are two schools as to where we stand. Firstly, we should genuinely take it at face value that the market overreacted and the ‘insurance’ cut we should expect is more realistically 25bp. The second, Williams actually poured his heart out, and gave us perhaps too much insight into the potential actions from the Fed in the July meeting, and where the broader Committee was now concerned that they lacked the shock factor to positively move markets. That being, if they cut by 50bp when it isn't full discounted, we could see asset prices react positively and importantly the USD heading south.
Asian markets are giving us a message
I’m sympathetic to both accounts, as the domestic data, on balance, warrants no change, although, given the external picture I have been arguing that the Fed was better off going hard than bringing a knife to a gunfight. There is clearly some impetus lost now, but what’s important is the market reaction through Asia. Granted, the odds of a 50bp cut now sit at 39.5%, but we’re seeing the USD remain soft, notably against the AUD, where AUD/USD is eyeing a re-test of the post-Williams speech high of 0.7082. Gold fell back into $1440 but is finding a base and looks likely to head back into $1450, and Asian equities are clearly bid, with the Nikkei 225, Hang Seng and ASX 200 up 1.7%, 1.1% and 0.7% respectively. S&P 500 futures are up 0.4%, despite US treasury futures up 3bp.
Commodities are also looking good, and it is a surprise to see copper up 1.8%, with Brent crude +2.1%, and we are starting to see better buying coming back into iron ore futures. In fact, if we look at the Bloomberg industrial metals index, this has had a cracking run in the past two months and is usually a good indicator of gains in the AUD.
(White - Bloomberg industrial metal index, orange - AUD/USD)
(Source: Bloomberg)
This may be premature, but it feels like the market is back on with the ‘race to the bottom’ trade. Consider if the Fed does go 50bp, which is a lesser proposition given the NY Fed statement, but it would give the ECB increased incentive to go hard in next Thursday’s ECB meeting.
The market has already discounted a 52% chance the ECB take its deposit rate, effectively the charge it passes to European financial institutions to park excess reserves on its balance sheet, down to -50bp. And, that would be considered punchy relative to expectations a week or so ago. We saw the Bank of Korea cutting yesterday, which was somewhat out-of-consensus, and the implied chance of the RBA cutting in November has pushed up to 65%.
Let’s see if there are any material changes from the BoJ, when they meet on 30 July. Because if they offer guidance, that they are ready to do more post-ECB, we just need more from the PBoC and markets will ride a new wave of liquidity. A few hypotheticals, but it’s not out of the realms of possibility.
EUR/AUD short positions looking compelling
I like EUR/AUD shorts here into the ECB meeting. The technical set-up looks bearish, and it feels like the AUD has been the best performer in the past two days for a reason – that being, there’s more to come. Rallies offer an opportunity to fade (in my opinion), and I am happy to close and admit I am wrong on a close through 1.6034. Happy to start with a small position, but if this kicks lower, I would be adding. As in life, if something is working, you try and do more of it.
With limited US corporate earnings in play tonight, the focus turns to speeches from Fed members Bullard (01:10aest) and Rosengren (06:30 aest). Both are voters, and we’ve heard from Bullard of late, which makes it interesting because if his caution increases, when he’s already stated, 25bp is the best course of action, then some may take this to mean 50bp is on the cards. One to watch.