Fed to Cut
US September core CPI was lower than expected at 0.1% vs. 0.2% expected. This unexpected read challenges the view that core inflations are rising. This increases our confidence that the 30th October rate cut will move forward. However, there is increasing evidence that core inflation will accelerate thru 2020. The primary reason for core CPI weakness was the collapse of used car sales due to lower financing rates on new vehicles. Used car sales are likely to rebound in October. Yet general gloomy US data, highlighted by soft ISM in both surveys, will pressure FOMC doves to cut again. The Fed minutes made it clear that member was more concerned about the downside risk to growth then upside danger of inflation. Minute even failed to mention the pass through effect of a tariff on inflation. This makes sense given the worry reads outside the US. This week saw Japanese core machine orders, a bellwether for the global economy, tank. One would think that all this conclusive information would have Oct pricing above 80%, but there is uncertainty. With little fanfare, the Fed has been buying short term paper. The official rationales have been to manage pressure on the repo market. Yet, call the action what you likely in reality its QE. The hawks will point to this operation as easing limiting the need for interest rate cuts. Should this lead to a pause Fed Chair Powell will look stupid, plus confirm the falsehood of “growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs.” The market and President Trump will likely get what they want in further interest rate easing, giving global equities and gold a boost while undermining USD.
GBP optimism has yet to consolidate
The latest developments on the Brexit front have put the Sterling on the sideline following daunting reactions of EU leaders over a Brexit deal submitted earlier last week. Yet Thursday’s meeting between British and Irish Prime Ministers Boris Johnson and Leo Varadkar boosted the British pound as a wave of optimism about an orderly Brexit increased. Although no further details of potential solutions concerning the Northern Ireland border have been revealed, the unexpected joint statement confirming “a pathway to a possible deal” should maintain GBP heavily solicited ahead of next week EU Council meeting starting next Thursday, a major event that should weigh on the Brexit fate.
Despite limited progress in the current Brexit impasse, both sides should resume talks today as well as during the weekend with debates probably focusing on a customs partnership solution that would allow Northern Ireland to exit the EU customs union with the UK while enforcing EU customs rules and tariffs on goods entering the region. Nevertheless, risks of a hard Brexit stay high as an exit proposal needs to be validated by EU leaders during the two-day summit starting on 17 October 2019 while UK Parliament special sitting on 19 October 2019 should either validate the deal agreed or request PM Johnson to ask the EU for another article 50 extension under the Benn Act. However, it is likely that, in this scenario, the British Prime Minister would bypass the appeal of MPs by sending two separate letters, the first requesting an extension and the second invalidating it, paving the way towards a no-deal Brexit. Following the GBP rebound, downside risk is likely to increase looking forward.
