Given yesterday’s decision of the US Federal Reserve not to raise interest rates, US dollar weakness for 2019 is on track. The Fed decelerated monetary policy and its tightening path, and it gave a very strong signal that interest rate cycle is finished. Fed Chairman Jay Powell shifted course, becoming dovish on policy rates and flexible on balance sheet reduction. Given the resilience of the US economy, the Fed has surrendered to market volatility. The Fed only slightly downgraded its growth outlook, stating that the economy is expanding at a “solid” pace versus “strong.” What is it with central banks and market volatility? Markets matter, and they directly influence central banks, even the detached Fed.
Risky assets rallied across the board, while the greenback fell. A March interest hike is completely off the table, and one in June is unlikely. A September hike is expected by only the thinnest of probabilities, then nothing in 2020. This sets a final target of 2.50-2.75% for this tightening cycle. We expected the Fed’s balance sheet to normalize around $2.0-2.5 trillion, which implies excessive reserves of approximately $2 trillion. Managed reduction of the balance sheet should help cool US inflation while not affecting risk appetite.
Optimism on US-China talks boost yuan
USD/CNY dropped 2.20% since the beginning of the year on US-China trade optimism, USD softness and China’s manufacturing rebound. However, the USD/CNY could rapidly turn north, as a trade deal with the US, China’s by far largest trade partner, would significantly reduce its trade surplus. USD/CNY is currently trading at 6.71, approaching 6.70 short-term.
A Chinese delegation led by Vice Premier Liu He and US trade representative Robert Lighthizer are looking for a trade resolution in a record period. Time is running short, as there are only 28 days to go before the implementation of customs tariffs, while issues of market access, intellectual property and China-owned companies’ subsidies remain unsolved. Markets’ hopes are rising with the recent arrival of People’s Bank of China Governor Yi Gang, who oversees financial institutions, which implies that talks are becoming more concrete on China’s financial market liberalization. A recent approval made by Chinese authorities to grant access to US company Standard & Poor’s rating agency to assess China’s bond market, the first authorized foreign credit agency to operate in the country, is a leap forward. Trade talks are focusing on China’s structural reforms and a timeline, a “soft resolution”, rather than a quick solution.
