Macro 6 minutes to read

Markets digest Powell’s comments ahead of the 'dinner of the decade'

Eleanor Creagh

Australian markets strategist, Saxo Bank

Summary:  The market has read the Fed chairman's latest remarks as dovish but the difference between this and earlier statements is marginal. Meanwhile, investors are eager to see whether Trump can master the art of making a deal with Xi.


Since the now-famous speech by Fed chair Jay Powell in early October saying that Fed rates were “a long way from neutral”, we have seen a variety of backtracking attempts by several of the bank's officials with various members outlining a more nuanced approach to tightening. 

Overnight , Powell notably observed that rates "remain just below the broad range of estimates of the level that would be neutral for the economy."

On balance this is marginally dovish, but no more than that. With the estimation that the neutral rate lies between 2.5% and 3.5% the bottom of the range is only one hike away (therefore we are “just below”), but we are five hikes away from the top of the range (“a long way”). Powell may be leaning on the dovish side in the way he delivered the statement to the market but depending which way you spin it the difference is marginal, there are plenty of ways to skin a cat.
Source: Bloomberg
We continue to see the December hike as dovish, with an expectation the 2019 dot plot will be revised downwards as the US economy is beginning to roll over and the Fed’s ability to continue tightening will disappear soon.

As always, the Fed ultimately will do what the data tell them to do, and we think whilst the absolute level of rates remains low by historical comparison, the dramatic pace of tightening will begin to show in the data. In rate of change terms this tightening cycle is actually one of the largest we have seen. 
Source: Bloombergand Saxo Bank
Recent inflation readings have either missed or met expectations. Economic growth will decelerate in most G20 economies in 2019. The headline CPI now has an increased sensitivity to goods and commodities prices and the recent 33% fall in oil prices will weigh on the headline inflation rate globally.

Given that energy has a weight of 8.1% in US CPI, a 10% YoY drop in the oil price reduces the headline CPI by around 0.2%. On average CPI surpasses PCE inflation by around 0.4%, so downside risks to the Fed’s inflation forecast for next year exist if current prices for oil hold. Already the collapse is weighing on inflation expectations with the US 10-year breakeven inflation rate declining 20bps to 1.95%. Along with the oil price decline, structural deflationary shifts outweigh the wage/price inflation linkage and are more powerful than the downdraft in unemployment.

On that basis we look for Treasuries to become a buy and the dollar to reverse its course, however, outright positioning may be premature at this point. We look for a move lower in yields after the Fed’s December meeting, this view can be expressed through call option strategies. For the dollar to reverse its upward trajectory we await 1H19 when we believe the Fed will pause and the relative growth leadership of the US economy will have faded. 

'The dinner of the decade'

The next catalyst for markets will be the G20 meeting between Trump and Xi this weekend. We believe risk assets will tactically trade in the green following a tariff ceasefire, negating the January tariff hikes and further impending tariffs. The Aussie dollar as the China risk proxy currency could be the relative winner here.

A tradable risk bounce on a handshake deal at G20 will be unlikely to reverse sentiment structurally as the underlying US/China relationship is still deteriorating. A handshake deal with little meat on the bones won’t do much to help the war of attrition unfolding over technological and economic dominance.

Whilst the meeting is encouraging, there is of course scope for the US trade hawks to push the hardline approach and the meeting could end with no agreement. Whilst we believe the first scenario is more likely, both sides must be considered as even within the Trump administration there is a marked split on the approach to China.

Vice president Pence sits on the side with the hawks and recent comments have been less than reassuring: “The United States, though, will not change course until China changes its ways”… “China has taken advantage of the United States for many years. Those days are over”.  It's fair to say there is no hint of compromise from Pence. Across the fence with the trade doves sit White House advisor Larry Kudlow and treasury secretary Mnuchin who are both concerned about the knock on effects in financial markets and the US economy. The good news, according to Kudlow: Trump is “open to a deal”.
Disclaimer

Saxo Capital Markets (Australia) Pty Ltd prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Combined Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Pty Ltd.
Level 25, 2 Park Street
NSW 2000
Sydney
Australia

Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Pty Ltd ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Combined Financial Services Guide & Product Disclosure Statement to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as CFDs and Margin FX products may result in your losses surpassing your initial deposits. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.
Please click here to view our full disclaimer.