The USD and Treasury yields were higher on Friday after a spokesman from the Fed provided some context to NY Fed President Williams’ dovish speech that had earlier caused a market reaction. This saw the NZD fall slightly ahead of the weekend, but remain solid on the crosses.
Friday’s price action was all about damage control following the market reaction to NY Fed President Williams’ speech we reported about in Friday’s daily. Recall that Williams said that “it pays to act quickly to lower rates at the first sign of economic distress”. We did note that the speech was “big picture” in nature and wasn’t specifically directed towards the current policy outlook but many in the market misread the signal and believed the Fed was signalling a likely 50bps rate cut at the meeting at month-end. This speculation was fuelled by vice-chair Clarida’s comments in a TV interview that followed Williams’ speech. Clarida said “You don’t need to wait until things get so bad to have a dramatic series of rate cuts…we need to make a decision based on where we think the economy may be heading and, importantly, where the risks to the economy are lined up.”.
After seeing the market reaction, with the market moving to price in as much as a 70% chance of a 50bps cut next week and the USD falling 0.5%, the NY Fed reported that “This was an academic speech on 20 years of research. It was not about potential policy actions at the upcoming FOMC meeting”.
This clarification triggered an unwinding of the move in rates and the USD through much of trading on Friday. Adding to the move, Fed President Bullard, one of the most dovish members on the FOMC, said that he favoured lowering rates by 25bps at the upcoming meeting, and referred to the “insurance cuts” enacted during 1995-96 and 1998 as examples similar to the current economic situation. And late in the trading session, the WSJ reported that “Fed officials are set to cut interest rates by a quarter-percentage-point at their coming meeting, and aren’t prepared for bolder action by making a half-point cut, as analysts and traders have speculated in recent days”.
So by the end of the week the market was back to pricing in about 30bps of rate cuts for next week’s meeting and some curve flattening through the session, with the 2-year Treasury rate up 6bps to 1.82% and the 10-year rate up 3bps to 2.055%.
In other news, tensions in the Middle East increased, with Iranian forces seizing a British-flagged oil tanker in the Strait of Hormuz. Earlier, a Liberian-flagged ship operated by the UK was seized but later freed. The Pentagon said that it is sending troops and military gear to Saudi Arabia as part of a move to counter Iran. The move follows “close encounters” all week between American warships and the Iranian military in the Strait and the US Navy’s shooting of an Iranian drone that got too close. Oil prices ended the week on a positive note (Brent crude up almost 1%), breaking four days of losses and trimming the weekly loss to about 6%, with concerns about slowing demand predominating over much of the period.
The 0.4% rise in the USD DXY index saw it take back almost all of the post-Williams loss. The NZD ended the week around 0.6760, after reaching as high as 0.6790 in the aftermath of the Williams speech. This capped off a weekly gain of just over 1%, making the NZD the strongest of the majors for reasons that aren’t all that convincing. Small gains were made on most of the crosses.
In economic data, the University of Michigan consumer sentiment index rose slightly, close enough to consensus, and maintaining a historically high level. Inflation in Japan remained low, with the BoJ making little progress in driving inflation towards its 2% target despite its ultra-easy policy settings. Yen was supported by the Middle Eastern drama, limiting its losses against the recovering USD. NZD/JPY broke 73 for the first time since early May and closed the week just under 72.9. Canadian retail sales were disappointingly weak, but the negative impact on CAD proved only temporary, with higher oil prices providing some support. NZD/CAD almost touched 0.8870, before ending the week at 0.8830.
The economic calendar is bare for the day ahead and in the coming days.