Weekly Market Update – 05 August 2019

USA MONETARY POLICY

A hawkish cut

The Federal Reserve did exactly what the market anticipated when it cut the upper limit on the target range for the Fed Funds rate to 2.25%. At the same time the Fed announced plans to
ease bond sales earlier than previously planned.

Still, the stock market sold off and the dollar gained. All because Jerome Powell’s comments in the press conference afterward were less doveish than had been expected. Indeed, some market participants have come to describe the fed’s policy move in terms of a ‘hawkish cut’.

We don’t buy that. Mind you, we hadn’t expected anything like a series of rate cuts. Indeed, the market appears to have reacted most awkwardly to the chair’s suggestion that the rate cut they’ve instituted is merely an attempt to ‘adjust policy to a somewhat more accommodative stance’ to insure against headwinds in the form of ‘weak global growth’ and to ‘support the return of inflation toward 2.0%’. Rather than beginning a long series of cuts of the sort the Fed might be expected to deliver in response to risks of a recession, the Fed’s response better reflects a ‘mid-cycle adjustment’.

In our view, there is little justification for anything more than the odd reduction in the main policy rate of interest. Inflation is muted and output growth has moderated but we’re struggling to see anything more serious than that.

As it stands, the market is pricing – to the point of near certainty – another cut when the Fed next meets again in September. Barring some emerging entente in trade talks with China, we reckon another rate cut is indeed likely. But that’s about it.

UK INFLATION REPORT

Uncertain

The Bank of England published its latest quarterly inflation report last week and, in the process, revealed it’s expectations for lower output growth for this year. Gross domestic product is expected to grow at just 1.3% compared with expectations in May for something like a 1.5% increase. Similarly, the risks are weighted toward an undershoot on the 2.0% target as far as inflation is concerned. But you can forget all of that; nobody can see beyond the next few weeks with anything approaching clarity. That’s why you can also forget Mark Carney’s suggestion that the Monetary Policy Committee is equally likely to raise rates as to reduce them. If the Bank of England raises rates anytime soon, we’ll eat the late Paddy Ashdown’s hat.

UK GENERAL ELECTION

Quite possible

The betting markets infer a probability of something like 54% that a general election is held before 2019 is finished, that’s up from 42% a few weeks ago. The likelihood that the current parliament sees out its full term with an election close to May in 2022 is just 14%.

We think an election is more likely than is currently priced by either the betting market, the capital markets or the foreign change market. If we’re right, expect the greater part of an additional associated uncertainty to play out in a still lower exchange rate.

Right now, the bookies are pricing a hung parliament at 58%, a Tory majority at 36% and a Labour majority at 12%.