Global Daily – Powell rubberstamps July rate cut

by: Bill Diviney , Nick Kounis

Fed View: 25bp cut a done deal; 50bp unlikely – Fed Chair Powell began his semi-annual testimony to Congress today with a very dovish prepared statement, seemingly aiming to quash the idea that the recent trade war truce and last Friday’s upside payrolls surprise might derail Fed easing. First, he restated the FOMC’s view from the June meeting that the Fed would ‘act as appropriate to sustain the expansion’, and that ‘the case for a somewhat more accommodative monetary policy had strengthened’ for ‘many’ FOMC members. He added that ‘since then (…) it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook’. As well as reiterating that ‘inflation pressures remain muted’, meanwhile, he gave this a further dovish twist by saying ‘there is a risk that weak inflation will be even more persistent than we currently anticipate’. Following the release of the remarks, Treasury yields fell 5bp, and OIS forward pricing for a July rate cut increased from 25bp to 31bp, suggesting markets once again see some probability of a 50bp cut. However, such a move looks unlikely to us given the broadly solid macro fundamentals, with rate cuts at this stage more about hedging against the risk of a further weakening in momentum rather than fighting a looming recession. Our base case continues to be for a 25bp cut at the 30-31 July FOMC, followed by another 25bp cut before end-2019, and another in Q1 2020. (Bill Diviney)

Euro Macro & Rates: Bond market reaction to production data looks overdone – Euro government bond markets sold off today. Yield rises were across the board, though the most significant moves were in the core and in the long-end, with curves steepening. The proximate driver seems to have been better than expected industrial production data out of France and Italy for May. French industrial production rose by 2.1% mom following a 0.5% gain in April. Italian production was up by 0.9% following a 0.8% contraction the month before. We think that the market reaction to the economic reports was overdone. Firstly, industrial production data is very volatile. Second, France’s industrial sector is not indicative of eurozone trends as it is one the less open large economies in the single currency area. Third, the body of evidence on the eurozone level points to an ongoing industrial recession and this fits with the weakness in the global economy that we are seeing. We think eurozone economic growth will remain weak in coming quarters as industry will remain in recession, and there will be some negative spillovers to currently resilient domestic sectors. Ongoing economic weakness combined with a substantial ECB stimulus package should see the downward trend in yields, curves and spreads re-assert itself. (Nick Kounis)