Short-end US rates and the USD fell after a dovish testimony from Fed Chair Powell overnight, reinforcing market expectations that the Fed will cut rates at its meeting later this month. US equity markets rose to new record highs after the testimony. The NZD had a mini ‘flash crash’ yesterday afternoon but it has risen strongly overnight amid broad-based USD weakness.
If there was any concern that the stronger than expected nonfarm payrolls report last week might lead the Fed to resist cutting rates later this month, Fed Chair Powell dispelled those with a dovish testimony and Q&A to Congress overnight. Powell reiterated the line from the June meeting statement that the Fed would “act as appropriate to sustain the expansion” and added that since then “uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.” In the Q&A, Powell explicitly said the payrolls report and US-China trade war ceasefire hadn’t changed the Fed’s outlook for the economy.
Powell outlined the Fed’s baseline that the US economy remains “solid” and the labour market “strong” with inflation expected return to target. But he emphasised a long list of downside risks including the global growth slowdown, the US debt ceiling, Brexit, the trade war, and the “risk that weak inflation will be even more persistent than we currently anticipate.”
The Fed also appears to be re-thinking the relationship between the labour market and inflation, with Powell noting that the link between the unemployment rate and inflation is “now faint heartbeat.” Powell said the Fed didn’t have “any evidence for call this a hot labor market…3.7% is a low unemployment rate but to call something hot, you need to see some heat.”
US rates had been creeping higher since the payrolls release last Friday, with the US 10 year Treasury yield reaching a high of 2.11% shortly before the Powell testimony, its highest level since mid-June. But rates declined quickly after Powell’s prepared remarks were released, led by the front-end of the curve. The 2 year Treasury yield fell 9bps, to 1.82%, with the market pushing up its rate cut pricing for July to 33bps (i.e. implying a significant risk of a 50bp move), compared to 26bps previously. The market prices 70bps of Fed cuts by the end of 2019 and just over 100bps by the end of 2020.
The US yield curve has steepened sharply, with the 10 year Treasury yield unchanged on the day (although well off its intraday highs) at 2.06% while the 30 year Treasury bond is actually 3bps higher in yield. A poorly received 10 year Treasury note auction added to the steepening pressure.
There hasn’t been much movement in response to the minutes from the June FOMC meeting which were released a short while ago given they reflected a similar message to the Powell testimony. The minutes set out that “many FOMC members judged that additional policy accommodation would be warranted if they [the risks and uncertainties] continued to weigh on the economic outlook.” Additionally, “many” participants worried that inflation expectations could be below levels consistent with the Fed’s inflation target.
US equity markets increased to fresh all-time highs in response to Powell’s dovish testimony. The S&P500 is currently trading 0.4% higher on the day, having briefly risen above the 3,000 level for the first time, while the NASDAQ 0.7% is stronger. 8 of the 11 sectors that comprise the S&P500 are higher on the day, with the Energy sector (+1.5%) leading gains on the back of a 3.6% rise in Brent crude oil after a much larger than expected decline in crude oil inventories. Brent crude is now trading at $66.60 per barrel, 10% higher than the recent lows reached in mid-June, with the market also nervous that Tropical Storm Barry has the potential to impact production in the Gulf of Mexico. The Financials sector (-0.5%) has been the worst performer on the day with market participants perceiving the lower rate outlook as negative for bank net interest margins.
In currencies, the US dollar’s recent strong run came to a halt after Powell’s prepared remarks were released. The USD is around 0.4% lower, in index terms, and remains firmly entrenched within its 2019 trading ranges. The EUR, JPY and GBP are all around 0.4% stronger on the day vs. the USD.
The NZD has outperformed amidst the broad-based USD weakness and is currently 0.6% higher, at 0.6645. Yesterday afternoon, the NZD experienced a mini ‘flash crash’, dropping around 0.5% in a matter of seconds in what appeared to be a liquidity vacuum. There wasn’t any obvious catalyst for the move in the NZD, but it was quickly reversed, and the NZD has moved higher overnight following Powell’s testimony. The NZD too remains firmly contained within its 2019 trading range (broadly 0.6500 – 0.6950), albeit in the lower-half.
NZ swap rates were higher and the curve steeper yesterday, following global moves the previous session. The 2 year swap rate was 1bp higher to 1.335% while the 10 year rate was 3bps higher to 1.75%. NZ swap rates still remain close to their all-time lows. We shaved our estimate for NZ Q2 CPI yesterday, to 0.5% QoQ and 1.6% YoY, after the release of food price data.
In other central bank news, the Bank of Canada kept its cash rate at 1.75% and said the current level of interest rates was “appropriate.” The Bank includes substantial discussion on the potential risks around trade tensions, which it said had clouded the outlook. Governor Poloz deflected a question on whether he still saw the chance of hike being greater than that of a cut, in contrast to his answers in previous press conferences. The market prices around a 75% chance of a Bank of Canada cut over the coming twelve months.
The second round of Powell’s testimony, this time to the Senate Banking Committee, is tonight. Several other Fed officials are also on the speaking circuit, including NY Fed President John Williams while US CPI is the highlight data-wise. The minutes to the ECB’s last monetary policy meeting are also released.