Fed’s ‘hawkish’ rate cut is more ‘dovish' than realised
06 August 2019 Washington
Image: Shutterstock
At the US Federal Open Market Committee (FOMC) meeting on 31 August,the Federal Reserve (Fed) cut interest rates by 25 basis points, which marks the first time the Fed has cut rates since the financial crisis in 2008.
Jay Powell, chairman of the Fed, indicated that the US central bank’s first rate cut in a decade does not necessarily mean it will be followed up with an aggressive rate-cutting programme.
Nigel Green, founder and CEO of deVere Group, said that the markets have been left reeling by the ‘hawkish’ approach taken by Powell as they had largely priced-in two more rate cuts this year based on previous signals by the Fed.
Green believes that, although an unpopular view, Powell made the right call in the current climate.
He highlighted that the markets want central bankers to give a clear forward path for rates, not nuanced, complex messages but they should not necessarily expect this to happen.
Green stated that the markets have given a knee-jerk reaction to something they were not expecting but if you read between the lines, Powell’s statement is more dovish than the markets have so far recognised.
Commenting on the Fed rate cuts, Fran Garritt, director, securities lending and market risk at The Risk Management Association, said: “In speaking with industry sources, the Federal Reserve’s decision to cut rates was reflected in the reinvest asset pricing as soon as it was telegraphed. The impact was immediate as many lenders continued to tie their rebate rate schedules to the Overnight Bank Funding Rate (OBFR) in several asset classes (including equities and corporate bonds).”
“So, while rebates were pegged to a static OBFR rate, asset prices out the curve priced in the rate cut a month before it happened. This led to margin compression until the actual cut was announced on 30 July. Factoring in the one-day lookback, the lender participants weren’t able to begin to capture the normalised spread scenarios they were used to in the past, until 2 August.”
He added: “This was short-lived as trade tensions once again escalated that very day. As a result, there is a current market expectation of another rate cut in September. The question posed is not ‘if’, but ‘how much’. Fed fund futures have currently priced in a roughly a third chance of a 50-basis point cut (vs two-thirds chance of a 25-basis point cut) in September. These actions will once again put pressure on reinvesting asset pricing, leading to continued margin compression.”
Meanwhile, Tom Elliott, deVere Group’s international investment strategist, has warned that there are winners and losers from the Fed’s rate cut and the US and global investors now need to revise their portfolio.
He observed that while the Fed’s first-rate in more than a decade had been widely expected it has divided the markets’ opinion.
Elliot explained that US stocks have taken heart from a recent upturn in domestic economic data and from the prospect of the Fed and other central banks easing monetary policy over the coming months.
It has been argued that this will help the current cycle of US and global economic growth, however, the US treasury market is indicating that a recession around the corner, Elliot noted.
Lee Ferridge, head of multi-asset strategy, the Americas, State Street Global Markets, has suggested that the Fed is clearly concerned by the recent data slowdown in parts of the economy and continued soft inflation prints.
Ferridge noted that while this move was characterised as more of an insurance cut, the FOMC may now be in wait and see mode to see if its fears over the trade war and global slowdown come to fruition.
He added that this less dovish message is likely to see short rates rise and the yield curve to flatten. It is also likely to see the USD gain further, while equity markets are unlikely to welcome the reduced prospects of more rate hikes to come.
Green explained that the Fed is “dismissing angry calls by the president and has ignored market expectations, thus far.”
He said: “Whatever happens in this current climate, those investors with a multi-asset, long-horizon approach are best positioned to reap the benefits and sidestep the risks.”
Elliot added: “The US and global investors now need to revise their portfolios to ensure that they are best-positioned to take advantage of opportunities and mitigate the risks as we enter what is likely to be a new era of rate-cutting for the Fed.”
Jay Powell, chairman of the Fed, indicated that the US central bank’s first rate cut in a decade does not necessarily mean it will be followed up with an aggressive rate-cutting programme.
Nigel Green, founder and CEO of deVere Group, said that the markets have been left reeling by the ‘hawkish’ approach taken by Powell as they had largely priced-in two more rate cuts this year based on previous signals by the Fed.
Green believes that, although an unpopular view, Powell made the right call in the current climate.
He highlighted that the markets want central bankers to give a clear forward path for rates, not nuanced, complex messages but they should not necessarily expect this to happen.
Green stated that the markets have given a knee-jerk reaction to something they were not expecting but if you read between the lines, Powell’s statement is more dovish than the markets have so far recognised.
Commenting on the Fed rate cuts, Fran Garritt, director, securities lending and market risk at The Risk Management Association, said: “In speaking with industry sources, the Federal Reserve’s decision to cut rates was reflected in the reinvest asset pricing as soon as it was telegraphed. The impact was immediate as many lenders continued to tie their rebate rate schedules to the Overnight Bank Funding Rate (OBFR) in several asset classes (including equities and corporate bonds).”
“So, while rebates were pegged to a static OBFR rate, asset prices out the curve priced in the rate cut a month before it happened. This led to margin compression until the actual cut was announced on 30 July. Factoring in the one-day lookback, the lender participants weren’t able to begin to capture the normalised spread scenarios they were used to in the past, until 2 August.”
He added: “This was short-lived as trade tensions once again escalated that very day. As a result, there is a current market expectation of another rate cut in September. The question posed is not ‘if’, but ‘how much’. Fed fund futures have currently priced in a roughly a third chance of a 50-basis point cut (vs two-thirds chance of a 25-basis point cut) in September. These actions will once again put pressure on reinvesting asset pricing, leading to continued margin compression.”
Meanwhile, Tom Elliott, deVere Group’s international investment strategist, has warned that there are winners and losers from the Fed’s rate cut and the US and global investors now need to revise their portfolio.
He observed that while the Fed’s first-rate in more than a decade had been widely expected it has divided the markets’ opinion.
Elliot explained that US stocks have taken heart from a recent upturn in domestic economic data and from the prospect of the Fed and other central banks easing monetary policy over the coming months.
It has been argued that this will help the current cycle of US and global economic growth, however, the US treasury market is indicating that a recession around the corner, Elliot noted.
Lee Ferridge, head of multi-asset strategy, the Americas, State Street Global Markets, has suggested that the Fed is clearly concerned by the recent data slowdown in parts of the economy and continued soft inflation prints.
Ferridge noted that while this move was characterised as more of an insurance cut, the FOMC may now be in wait and see mode to see if its fears over the trade war and global slowdown come to fruition.
He added that this less dovish message is likely to see short rates rise and the yield curve to flatten. It is also likely to see the USD gain further, while equity markets are unlikely to welcome the reduced prospects of more rate hikes to come.
Green explained that the Fed is “dismissing angry calls by the president and has ignored market expectations, thus far.”
He said: “Whatever happens in this current climate, those investors with a multi-asset, long-horizon approach are best positioned to reap the benefits and sidestep the risks.”
Elliot added: “The US and global investors now need to revise their portfolios to ensure that they are best-positioned to take advantage of opportunities and mitigate the risks as we enter what is likely to be a new era of rate-cutting for the Fed.”
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