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The Fed has run out of patience

Cross asset weekly pic
The Fed gave what markets wanted: a clear signal that now is no longer the time to be ‘patient’ – the word was removed from the statement. Instead, it will ‘act appropriately’ as uncertainties about the outlook have increased and inflationary pressures remain muted. Unless there is a substantial improvement in the incoming data ahead of the July meeting, which we think is unlikely, the Fed made clear that it will cut rates. With markets already way ahead, pricing in four rate cuts over the next 12 months, the Fed clearly felt constrained to send out a signal since any hesitation would have exacerbated the situation with further fears about potential yield curve inversion and possible negative spillovers to risk assets and financial conditions.
While the dot plot was clearly more dovish than expected, with eight FOMC and regional Fed members expecting lower rates this year and seven of them by 50bp, no member thinks there is any risk of recession any time soon, a view that we share. Actually, the unemployment rate is seen to fall by more than previously anticipated and growth was revised slightly up for 2020. Core inflation will take more time to get to 2% than forecasted 3 months ago, and the terminal rate has been revised down by a quarter of a point. In some ways, this suggests that policy is probably tighter than previously thought, justifying future ‘insurance’ rate cuts.
In our fixed Income note, we explore how yields performed when the Fed did ‘insurance’ cuts in 1995 and 1998. In both instances, yields initially fell but then rose and the curve steepened. This also means that in the near term, looser monetary policy in the US and Europe, and a return to super-low government bond rates in developed markets, are likely to drive a renewed hunt for yield and support better returns from Emerging Market (EM) assets. More fundamentally, we still expect the recovery in China’s economy later this year to drive the next leg up in markets.

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