By Phil Lynch
Welcome to Fed Week – a pivotal week where the US Federal Reserve will reverse course and cut interest rates by 0.25%. We can confidently say this given the clear forward signalling by the Fed over the previous few months, along with the current market pricing for future interest rates. We can expect there to be heightened volatility throughout the week.
The Fed are looking to cut rates, because they are concerned about the level of growth both in the US and further abroad. Last week’s US GDP numbers came through at 2.1% – which was better than what was expected by markets, but nowhere near President Trump’s promised 3%+. This is in large, a direct result of the ongoing trade wars with China – for which talks will be restarting this week.
Other economic data releases impacting the US dollar this week are relentless and include:
The only NZ specific data point of note will be ANZ Bank’s Business Confidence survey – and this will likely get lost in the crowd (along with showing poor confidence levels, as it has done ever since the Labour led government took control). Next week will be far more important for NZ data with both the Unemployment Rate and the OCR decision due on 6 August and 7 August respectively.
The US Federal Reserve decision will be the main event this week. The Fed has clearly signalled a rate cut of 0.25% will be the likely outcome, taking the range to 2.00-2.25%. There was some discussion that a 0.50% cut might be a possibility, but that was later clarified to mean further rate cuts will be likely, but at a later FOMC meeting.
Given this signalling, markets have been able to fully price in a rate cut on Thursday morning, but they have been unable to determine the pace and depth of rate cuts that will follow. Therefore, the important piece of Thursday morning’s announcement will be the forward guidance the FOMC give to the pace of future rate cuts – and there are two schools of thought as to which way the Fed will go.
On the one hand, the US Federal Reserve is set to join the chorus of central banks that are looking to stimulate their economies through more accommodative monetary policy. Markets are currently expecting as much as 1% of rate cuts over the coming 12-months. This is largely inline with the RBNZ’s own course for lower rates – and would result in a relatively neutral exchange rate outlook on the NZD/USD as a result.
On the other hand, many are concerned as to why the Fed is signalling the need to cut rates so aggressively. For starters, Unemployment is near record lows at 3.7%, Inflation is super-close to target at 2.1%, and the US stock market is at record highs – the Dow Jones Industrial Average climbing above 27,000 for the first time in July. Therefore the Fed should be cautious with their pace of rate cuts – as it is their main tool for stimulating the economy in the event of a broader economic downturn. I get the feeling the US Fed may underwhelm the markets expectations for additional rate cuts. This would mean higher US interest rates than is currently expected, and this would be NZD/USD negative.
This week is also stacked with key US data that the Fed uses to form their view on rates. Underlying weakness (or lack thereof) will justify the Fed’s expected course of rate cuts. The Fed pays close attention to Consumption – which makes up 70%+ of US GDP. This is expected to rise by 0.3% for the month of June. Underpinning this will be the Core PCE Deflator – which measures the prices paid by people for domestic purchases of goods and services, excluding the prices of food and energy. The Core PCE is the Fed’s preferred inflation measure, with a 2.0% target, and an expected 1.7% result this Wednesday morning. Anything at 1.7% or lower will support the Fed’s course of rate cuts.
The other flagship data release will be the US Non-farm Payrolls number. Markets are expecting 169k new jobs to have been created in July, which will see the Unemployment Rate drop to 3.6% and Average Earnings climb to 3.2% – all signs of a strong economy that would effectively undermine the need for the Fed to cut rates.
The NZD/USD plummeted 2.4% over the past 10 days. However, this drop was been more of a correction which followed the 4.7% increase from the lows reached in mid-June. Perhaps the 0.65 – 0.67 cent range is still fair-value for the NZD/USD, despite the recent spike higher. This week – anything within the 0.65-0.67 range is fair game by the end of the week.
Wednesday brings the release of Australian CPI data, which is expected to climb to 1.5% following last quarters 1.3%. At these levels, inflation is still well behind the RBA’s target and therefore justifies their course of rate cuts.
The BoE is expected to keep rates on hold at 0.75% when it announces its decision on Thursday evening. Leaving rates unchanged, will be in direct contrast to most other central banks. The BoE’s Chief Economist, Andy Haldane, has compared their course for interest rates to a golfer who does not know which course he or she will be asked to play (referring to Brexit). Perhaps now that Boris Johnson has committed to Brexit one way or the other, the Bank of England will join other central banks and adopt a more dovish stance.
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