Fed View: Base case of a 25bp cut, but a tactical 50bp move is possible – Following a remarkably dovish performance from Fed Chair Powell after the June FOMC meeting last Wednesday, markets will be looking for further guidance from Fed officials due to speak this week (Powell and Barkin later today, Bullard and Daly tomorrow). The focus has since moved from whether the Fed will cut rates in July, to by how much they will cut. Our base case remains that the Fed will cut by 25bp. While the case for easing is strong – inflation is muted and expectations are falling, and the downside risks to the outlook are elevated – current macro conditions in the US remain solid, on the whole, and therefore do not warrant an aggressive policy response. However, Chair Powell strongly hinted that a 50bp cut was on the table by seemingly endorsing academic research making the case for earlier, more aggressive policy moves when policy space is limited. As a result, we do see a risk that the Fed cuts by 50bp in a tactical move, to get the ‘most bang for buck’.
Downward pressure on yields to persist – Whether the Fed cuts 25bp or 50bp in July would therefore not alter our view of the total policy easing we expect from the Fed – 75bp by Q1 2020. Rather, we would view it as a frontloading of rate cuts rather than as a signal that more aggressive cuts are coming. However, markets are likely to continue to overshoot in the near-term, particularly if the Fed does cut by 50bp in July, and we expect a further move lower in yields – to 1.6% in 2y yields and 1.9% in 10y yields by year-end. With OIS forwards pricing in c.100bp of cuts by early next year, we are probably approaching the peak in easing expectations. But we are not there yet.
Could the G20 outcome change matters? – Chair Powell made it clear last week that US-China trade negotiations were not the only factor driving Fed policy. We think that much of the damage from the trade war is done, in weaker confidence and elevated uncertainty, and that the Fed will ease regardless. What a G20 deal this weekend could do is lower the chance of a 50bp move in July, and potentially reduce the amount of total easing the Fed implements. However, we do not think a US-China deal would derail rate cuts altogether. (Bill Diviney)
Gold: Year-end target at USD 1,400 reached – The prospect of aggressive monetary policy easing by the Fed has weighed on the US dollar in a risk-on environment. Lower US rates and a lower US dollar have boosted gold prices. Our year-end target of USD 1,400 per ounce has been breached and prices have even rallied to USD 1,430 per ounce. What do we expect going forward? In the near-term, the possibility of a 50bp rate cut by the Fed in July will continue to support gold prices. In addition, the price momentum is strongly positive, as is the technical gold price outlook. Dovish central banks are likely here to stay, and this is a major support. Gold is not paying interest, so if interest rates elsewhere (such as in the US) decline, this will increase the relative attractiveness of gold as an investment asset. However, our US economist expects the Fed to cut by only 25bp rate at the meeting in July. If Fed speakers sound less dovish or if the Fed doesn’t deliver a 50bp rate cut, gold prices could drop considerably, because speculators hold extreme net-long positions in gold. Even though the trend in the US dollar index has turned negative after breaking below the 200-day moving average, we do not expect a weak dollar across the board. A deterioration in investor sentiment will favour the dollar versus gold. We keep our year-end forecast for gold prices at USD 1,400 per ounce, which suggests gold prices are currently overshooting. (Georgette Boele)
Asia Macro: Growth forecasts downgraded, as trade conflict hits supply chains – We have recently adopted a more negative view on trade tensions and the impact thereof on the global economy. As a result, we have lowered our growth forecasts for a wide range of advanced and emerging economies, while expecting a global easing cycle to cushion the blow. We have also cut our growth forecasts for export-oriented emerging Asia, as the (re)escalation of the US-China trade/tech conflict has left its mark on regional supply chains (US-China trade has collapsed in recent months), on business confidence and on financial conditions, while external demand has softened. We cut our growth forecasts for China only modestly (for 2019 from 6.3% to 6.2% and for 2020 from 6.0% to 5.8%), as we expect more policy support to offset the larger drag from the trade conflict. That said, these revisions should be taken in the context of the relative stability of the official growth figures, whereas we expect more weakness in trade and manufacturing. For the majority of the other EM Asian countries, we cut our 2019-20 growth forecasts by around 0.5 ppt. As a result, we now expect regional growth to slow from 6.1% in 2018 to 5.7% (down from 5.9%) in 2019 and to 5.5% (down from 5.8%) in 2020. For more background see our Asia Watch: Trade conflict hits Asian supply chains, published earlier today. (Arjen van Dijkhuizen)