Fed likely to change language at FOMC meeting
Trade uncertainties, Trump’s pressure to cut interest rate and weakening economic data: all seems blurred as to how the Fed should react. Market interpretation should play an important role in the future development of the greenback as well. Treasuries continue to gain traction, with yields lowest in over a year across all maturities as expectations of Fed Funds Rate cuts, uncertainties amplify. Although no rate cuts are expected for Wednesday meeting, changes in forward guidance and the Fed’s dot plot are largely anticipated.
During its monetary policy meeting, the Fed is about to turn more dovish, with a shift in language from “patient” to more flexible, paving the way for one rate cut this year and additional easing in 2020 as well. GDP and inflation forecasts currently set at 2.10% and 1.80% will likely be revised downwards as deteriorating economic data support the trend. Nominal and Core PCE given at 1.50% (prior: 1.40%) and 1.60% (prior: 1.50%) in April remain below the 2% target while manufacturing activities downtrend are approaching contraction territory as a result of escalating trade war with China. Furthermore, major problems related to Trump’s interference in the Fed’s affairs constitute a major obstacle for the central bank, which is supposed to preserve its independence to ensure credibility and avoid long-term difficulties, in particular when stabilizing the economy and the dollar. Certainly, an escalation of political pressure would most likely negatively affect USD and conversely the US economy.
As ECB President Mario Draghi speech about stimulus is weighing on the EUR, we expect EUR/USD (1.1185) to approach 1.1175 short-term while June ZEW figure of -20.2 (prior: -1.6) for the Eurozone should support the decline.
Oil Strange Curve
Clearly, we are not in the 1990’s were the smallest disturbance in the middle-east would cause chaos in energy markets. Tension is rising in the Gulf region as attacks on two tankers near the Strait of Hormuz have put the US and Iran on a collision course. Despite traders being caught short, as they anticipate further weakening of global demand, the upwards bounce was limited. On Friday, the IEA reduced global oil demand growth in 2019 for a second consecutive month highlighting demand issues that have been bulldozing oil prices downwards. Yet the long-term outlook for oil looks stronger especially at $51 brl. The trade is reported to be short the front-end while building longs on the back end of the curve (locking in a cheap price for future delivery) in expectation of steepening. The middle of the forward curve remains ultra weak and complicated (markets understand that the forward curves is not a reliable forecast of futures prices). With the middle-east gulf region on a hair trigger, US summer coming in hot and slower global demand already pricing in, the upside in oil looks attractive. Especially considering how short the market has become in the front-end. Our trajectory for higher oil prices through year-end remains intact, lack of reaction to supply complexity and softer demand is hurting the market further than initially anticipated.
Norges ‘Dovish hike’
Speaking of oil, we expected the Norges banks to raise policy rates by 25bp. The Interest rate path from March meeting explicitly commits to a hike. Yet, the policy adjustment is likely to be a ‘dovish hike’, considering the negative macro backdrop. Norway’s growth is hovering around 3% with strong labor market pressuring inflation (in-line with forecasts). With the hike fully priced in the real question is what is next? Global yields have fallen sharply as market pricing in easier policy from the Fed. Oil prices, despite risks to supply, prices have fallen 20% from April’s highs. Above a hike this week, markets are pricing in 6-7 bps of tightening for the rest of 2019. Interesting the Norges Board will only learn of the FOMCs strategy after their own decision. A dovish hike and pilling back calendar-based forward guidance will be a short-term negative for NOK (especially considering how short the markets are already in NOK).
