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Mixed signals : Rates , Trade and Oil

November 29, 2018

 

ref :-  General

 

Plenty going on today, and much of it revolves around yesterday's comments from Fed Chairman Jay Powell. More doveish noises from Fed personnel of late had encouraged traders to believe that the Fed might be adjusting it's stance on monetary policy, and Mr Powell's words seemed to confirm that . In particular, his statement that rates were currently somewhere "just below" the neutral rate caught the attention.

 

You'll remember that the neutral rate of interest is defined as the rate that both encourages full/maximum employment but at the same time keeps control of inflation. Another common way of putting it is that it is the rate that neither stimulates nor restricts growth. The "just below" description of current levels is significant because as recently as early October Mr Powell described rates as a "long way" below neutral, which was consistent with the Fed's forecast of three rate rises in 2019 .

 

It's always difficult/impossible be precise about future neutral rates of interest, but the implication of Mr Powell latest speech is that the Fed may now be thinking that the level may have come down from around 3.0% to 2.5%. In other words .... if you take a 25 basis point hike in December for granted (and most people still are), that means just one hike in 2019 instead of three. The prospect of a more cautious Fed implementing a slower path of rate hikes towards a lower ceiling had predictable market effects : a jump in equity prices (particularly momentum stocks) ; a fall in the dollar (good news for emerging markets) ; a fall in bond yields (and rise in prices)  --  the US 10yr yield has been as low as 3.00% and in doing so broke down through the lower end of its trading range since mid-September (so much for yields headed for the moon).

 

The idea that the Fed will hike just once in 2019 coincides with what the market has been telling us (from the prices of interest rate futures contracts) for a while. Does that mean we should take it as read ? We would urge huge caution about that at this stage. Even if the more hawkish calls for four hikes do look a bit extreme now , there's a view (voiced by Soc. Gen., amongst others) that Mr Powell was rectifying a rookie mistake he made with October's "long way below" comments. Those gave him little wriggle-room if things started to slow down. It's also worthwhile noting that Mr Powell took the opportunity to reassert the fact that future rate decisions would be data-dependent.

 

Some may remember that the old data-dependent call winds us up a little because ALL decisions of that nature must in a large degree be data-dependent. What are the authorities going to do ? Ignore the evidence ? But that aside, it does mean that the Fed is reminding us of its right to tailor policy to the conditions ..... and since the Fed still takes the view that economic growth in the US will continue to be "solid", with high employment and inflation already at target levels, that implies that one hike in 2019 is no more set in stone than three hikes were.

 

About the trade thing ..... the likes of Japan and Germany will be sweating a bit this morning after an ill-tempered President Trump declared that if the US had imposed sensible tariffs on the importation of automobiles, then General Motors would not be closing down factories and making workers redundant back in the USA. Not a good sign ..... though what Mr Trump says is not necessarily what Mr Trump does  --  it may be just establishing a stronger bargaining position. China too will be hoping that recent comments from the Team Trump are not the full story, or else the prospects for the President's bilateral meeting with President Xi Jinping at the G20 conference in Buenos Aires might be a little bleak. A further $265 billion in US tariffs may be just around the corner.

  

Still looking for that bottom in the oil price ? It's down again, with WTI crude trading at 49.95 and Brent at 58.50, this time undermined by President Putin's remark that Russia would be just fine with (Brent) crude at $60 .... which frankly came as something as a surprise. It's possible that Mr Putin's relaxed position in part emanates from the currency markets. Even after a better performance of late, the Rouble is still down about 17% against the Dollar from the levels seen in January. With oil trading in the US currency, to some degree they have had a measure of protection from the worst of the price fall. The Saudis, with the riyal fixed against the Dollar, have no such compensation.

 

 

We're not at all sure that Saudi Arabia would be so content with $60 oil even taking into account the balancing act they have to perform to satisfy President Trump's demands for cheap oil, and the possible ramifications if they lost his support at this difficult time. Another crucial Argentinian meeting on the sidelines is on the agenda, this time between Russia and Saudi Arabia. Will they agree on a plan to support prices that they can put forward at the OPEC meeting next week ? If so, what price would they have in mind ? For the Saudis, as dilemmas go it's a doozie ....

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