A week where the odds for rate cuts rise

June 3-7, 2019

Risk sentiment weighing on implied policy rate probabilities

Mounting concerns over the global economic backdrop are keeping market-implied policy rate trajectories well anchored across much of the G10 currency pairs. The broader economic fallout from the Sino-U.S trade war has been relatively limited so far, but both sides have become increasing entrenched and seemingly unwilling to concede any ground in negotiations. This is altering perceptions about the potential duration and severity of the unfolding trade war and, in turn, fuelling expectations that central banks will soon need to ease monetary policy. Discussions between Trump’s administration and Mexican officials over tariffs ended Wednesday without agreement.

The US dollar has remained on the defensive for most of this week after various Fed speakers spoke openly about a potential rate cut – an interest rate cut might be warranted soon due to trade and inflation risks.

Fed rate cut bets are increasing by the day, and if that remains the case, the dollar could continue to weaken. Delays in progress with the multi-front trade wars and further deterioration in U.S economic data could raise the bar to two -25 bps by end of summer.

Central Banks

Markets are adjusting to the sudden “dovish” turn of G10 central banks. While the re-pricing of the Fed has led the way, the RBA’s Lowe has followed up the well sign-posted -25 bps cut at this week’s meeting with more than a hint of further easing to come.

The one outlier, thus far, the BoC statement at their May meeting was far less ‘dovish,’ in fact, it provided an encouraging tone regarding the domestic economic outlook. The BoC placed significant emphasis on the improvement of Canadian labour and housing market, contrasting directly with the more downbeat RBA.

The Fed’s Bullard (dove, voter) stated that rate cuts may be warranted soon to lift inflation – he has been the first Fed member to comment on a rate cut. He cited that “low unemployment was no reason for Fed policy to stand pat,” and that “trade dispute might have larger impact on global markets. US economy is facing “mounting risks” to its economic outlook.

This week’s U.S ADP employment reading was the worst since 2010 (+27k in May vs. +185ke) has put a -25bps cut at the Jun 18-19 FOMC on the table. That outcome is now priced at +21.3% (+6.7% w/w), July is +73.2% (+28.5% w/w) and Sept. at +95.3%.

The ECB provided no surprises and left overnight rates unchanged as expected on Thursday. However, the ECB said key interest rates will remain at “their present levels at least through the first half of 2020,” having previously said this would be until the end of 2019. This is the second postponement of the forecast first rate rise this year. The central bank also revealed the pricing of the new series of quarterly targeted longer-term refinancing operations, which “will be set at a level that is +10 bps above the average rate applied in the Euro system’s main refinancing operations over the life of the respective TLTRO.

Brexit

U.K PM Theresa May officially steps down on June 7 and under the rules set out by the Conservatives, any MP wanting to be leader now needs eight supporters to put their name in.

Nominations will open and close June 10, and Conservative MPs will whittle the field down to two in a series of votes.

• Voting among MPs is planned for June 13 and then June 18, 19 and 20. Candidates will need to get at least 16 votes to survive the first round, and 32 to survive the second. After that, the candidate with the fewest votes will be excluded in each round.
• Conservative grassroots members will have a month, from the week beginning June 22 to the week beginning July 22, to choose the winner out of those two in a postal ballot.
• It is the first time the Conservatives have chosen a prime minister in this way. In 2016, May became leader by default when Leadsom dropped out of the race

Trade wars

Senate Republicans are threatening to block President Trump’s proposal to introduce progressively higher tariffs on Mexican exports if the country does not restrict the flow of migrants passing through its borders. Duties would start at +5% by next week before ratcheting up to +25% by October. The pushback is being considered a positive development, as tariffs on Mexico would signal to the rest of the world that trade agreements with the U.S “cannot be relied on.”

World Bank

The World Bank lowered its outlook for global growth, noting that “international trade and investment flows dropped faster than expected in the first six-months of the year, curtailing economic activity.”

Currently, global economic growth is on track to be the weakest since 2016, while trade growth is set to be the weakest since the financial crisis in 2008. The world economy is expected to expand at a +2.6% pace this year and below its +2.9% forecast made in January.

Economic events

On the Economic Calendar, it’s a Bank Holiday in Australia (June 9) and there are no economic calendar events on this weekend.

Market concerns

• UK leadership scramble & Brexit fallout
• US-Sino – China standing firm against US
• Trans-Atlantic trade tensions to intensify
• OPEC, Saudis, Venezuela, Libya & Trump
• Iran is threatening to close the Strait of Hormuz
• Venezuela/Russia/U.S tension
• Geo-political concerns in Iran, Russia, Ukraine & France
• U.S ramps up trade talks with India and Turkey
• MXN vulnerable on Mexico officials conceding deal not happening anytime soon
• Italian deputy PM Salvini is threatening to end the Govt tenure

This week: U.S & CAD employment (June 7). Next week: CHF, Fr. & Gr. Bank holiday, GBP GDP & manufacturing production (June 10), GBP average earning’s index (June 11), U.S CPI & AUD employment (June 12), SNB monetary policy assessment & press conference (June 13), U.S retail sales (June 14)

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