After the abysmal and rather embarrassing performance of Fed Chairman Jerome Powell at the July FOMC meeting yesterday, one wonders the point of even having a central bank when as opposed to having a handle on things, they are entirely clueless. After a month of much deliberation following Trump's angry tweets at the "horrid choice" Powell, and the U.S. economy printing slightly better than expected data in July, the Fed decided to cut rates by only 25 basis points and roll off the balance sheet normalization (quantitative tightening) in August as opposed to September.
Some market participants eagerly awaited a 50 bps cut even though the probability that cut in last few weeks went down to 18% prior to the meeting. One has to realize that the Fed is starting from a level of 2.25%, so if cycle indeed turns out to be a recession, then they have little ammunition left to offset that. Also, 50 bps would send the wrong message to the market. Admittedly, a Fed very scared of the financial market risks jumping the gun, would have created a panic rather than encourage one. It chose wisely to cut only 25 bps, but one begs to ask, did it need to be cut at all? A very politically contentious debate.
There were two dissenters on the panel that suggested rates should stay on hold, perhaps implying that a rate cut for September is not entirely in the bag. Although the bond market disagrees as the curve gets more inverted and 10 year US yields trade at 1.96%, back below the key 2% number following Powell's press conference. In his prepared statement, Powell kept insisting about a U.S. economy being healthy and growth robust, yet worried about global growth development, muted inflation just not picking up, and trade uncertainty (aka Trump is making my life miserable and wants some firepower to coerce the Chinese into giving into his demands).
At the very least the Fed could say if growth showed signs of contraction and financial markets tightening warranted a rate cut, that this would have earned him some respect. When asked questions on why cut now or if this was a one-off, Powell kept going back and forth as he saw markets tick up and down, a rather pathetic response from the chairman of the Federal Reserve! The fact of the matter is that he just does not know. This was just an insurance cut to offset the rate rise in December 2018. This will buy him some time to see whether the U.S. and China reach an agreement and/or U.S. data gets better or worse. He suggested this was not the start of a long easing cycle, but could also raise rates if need be. Not a clear answer.
It seems that the Fed has now become central bank for the world. With China, Europe, and Japan Manufacturing PMI's all signalling contraction, it seems to be a race to see which central bank will cut the most and how fast. U.S. Manufacturing PMI fell to its lowest level since September 2009, at 50.4, and ISM Manufacturing fell to 51.2, the lowest since August 2016. So, things are getting bad, but the economy is still growing as the index is still >50 contraction level!
It is the technical setup of the equity market and volatility that is concerning. The former is losing momentum and is at highs whereas the latter is forming a trough and at risk of a sharp increase. Both indices broke out of their wedge patterns and that is what caused the selloff following the press conference. This is worth monitoring as if volatility rises any higher, the S&P 500 will be sure to fall.
China and the U.S. held trade talks this week in China, which concluded half way through at an impasse. With no resolution on Huawei, Taiwan, and removing tariffs already in place, the Trade War will continue to drag on.
The dollar had rallied significantly going into the Fed FOMC meeting. There is no doubt that the dollar is the lesser of the evils as its growth remains robust relative to rest of the world, but there will be periods of underperformance in a bull tape. The bond market is sure that yields need to go lower, hence the dollar may start to track the bond yields and start to fall. It seems the bond market will force the hand of the Fed to cut rates further, whether they like it or not. Currently there is a divergence between what the bond market is pricing in (yields) and what the equity market assumes (sustained expansion). When will this gap close? Perhaps in the fall.
We are entering the quiet August period where logic and fundamentals do not work. Most will close shop for the remainder of the month and real price action should happen in September when we have had a chance to see more economic data and/or bond market damage. For now, copper is trading below $5900/tonne and can see some support, and with s significant dollar rally already priced in, it is time to be flat for now.
There is a real risk brewing in global financial markets. If the markets rally to new highs in August, or if the data is not as bad, the Fed may not cut at all in September. Or perhaps the Fed will continue to cut rates but for that the markets needs to declinel greater than 10%.
But let's see how August pans out first as the buy the dip traders return once again.