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Dovish Fed, Recession Risks, Prolonged Trade War, Brexit Fatigue

Dollar tumbled sharply overnight as FOMC economic projected turned out to be much more dovish than expected. Selling continues today, in particular against the Japanese Yen, which is lifted broadly on after the sharp decline in US treasury yields, in response to FOMC. While stock markets are just mixed, risks are piling quickly. Firstly, Fed’s dovishness now pushed the most reliable part of the yield curve on the brink of indicating recession. Secondly, Trump hinted that he’s going to extend the ongoing trade war with China even if the latter agrees to a trade deal. The damage to the world economy by the two countries could extend for a long-period of time.

Staying in the currency markets, Canadian Dollar is the second weakest for today even though WTI crude oil surged through 60 handle on sharp decline in oil inventory. New Zealand Dollar is the strongest one following solid rebound in Q4 GDP. Australian Dollar follows as unemployment rate dropped to lowest since 2011. Sterling is mixed for today even though it’s the weakest one for the week. EU summit in Brussels will be watched for formal responses to UK’s request for Article 50 extension.

Technically, EUR/USD’s break of 1.1419 resistance is taken as the first sign of medium term bottoming. Focus will now turn to 1.1569 resistance in near term. Similarly, USD/CHF break of 0.9926 support also suggests medium term topping. Focus will turn to 0.9716 support. USD/JPY will take on 110.35 key support to confirm near term bearish reversal too.

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In Asia, Japan is on holiday. Hong Kong HSI is up 0.17%. China SSE is up 0.94% at 3119, back above 3100 handle. Singapore Strait Times is up 0.14%. Overnight, DOW dropped -0.55%. S&P 500 dropped -0.29%. But NASDAQ rose 0.06%. 10-year yield dropped -0.079 to 2.525. 30-year yield dropped -0.053 to 2.975, lost 3% handle.

Dovish Fed projections point to no hike in 2019, slower GDP growth and higher unemployment rate

Fed left federal funds rate unchanged at 2.25-2.50% as widely expected. The statement offered no surprise at the committee will remain “patient” regarding future adjustments to interest rates. Fed also decided to terminate the balance sheet reduction plan in September this year.

The shocks came from the all-round, deeply dovish economic projections. In short, there will be no more rate hike in this year. And the current rate hike cycle could end with interest rate below longer run rate. GDP forecasts for 2019 and 2020 are revised down. Unemployment rate for 2019, 2020, and 2021 are all revised up.

Federal funds rates are projected to be at: 2.4% in 2019, revised down from 2.9%; 2.6% in 2020, revised down from 3.1%; 2.6% in 2021, revised down from 3.1%. Median longer run rate is unchanged at 2.8%. That is, there will be no rate hike this year. And probably just one hike in 2020 and it’s done. The current cycle could end up with interest rate below the longer run level.

GDP growth is projected to be at: 2.1% in 2019, revised down from 2.3%; 1.9% in 2020, revised down from 2.0%; 1.8% in 20201, unchanged. Unemployment rate is projected to be at; 3.7% in 2019, revised up from 3.5%; 3.8% in 2020, revised up from 3.6%; 3.9% in 2021, revised up from 3.8%. Core PCE inflation is projected to be at: 2.0% in 2019, unchanged; 2.0% in 2020, unchanged; 2.0% in 2021, unchanged.

Drastic moves were seen in the bond markets with yield curve now indicate intensified risks of recession ahead. The most reliable recession indicator is now flashing red after yesterday’s moves in the bond markets. The spread between 3-month yield and 10-year yield has narrowed sharply and at brink of inverting. The slope of 3-month and 10-year yields is watched by most economist and seen as the best recession indicator.

Suggested readings on FOMC:

Trump hints at extending trade war and keep tariffs on China for a long period of time

Trump said his administration is talking about leaving tariffs on China for a long period of time. That is, even if a trade agreement is reached, the tariffs won’t be limited until China complies with the terms of the deal. His comments come just ahead of USTR Lighthizer’s trip to Beijing next week to resume the negotiation.

He said: “We’re not talking about removing them, we’re talking about leaving them for a substantial period of time, because we have to make sure that if we do the deal with China that China lives by the deal. Trump also criticized that China  had a lot of problems living by certain deals.”

China has yet to have a formal response to the comments yet. But what Trump said were generally seen as counter productive to the negotiation, as well as the world economy. Without US stopping the punitive tariffs, China will certainly not agree to correcting its unfair trade practice while lifting its own retaliatory tariffs at the same time. The US won’t have it all. That is, even if there is an eventual agreement and China will speed up it’s reforms, tariffs from both sides will stay there for much longer.

As we emphasized before, there is no trade truce for now, no ceasefire. The tariffs are the “cannons” of trade war and they are bombing both economies everyday right now. They’re hurting the world too and will continue to do so for a long period of time as Trump indicated.

EU would grant short Brexit delay only if Commons approve the deal

UK Prime Minister Theresa May formally wrote a letter to European Council President Donald Tusk yesterday, seeking for Article 50 extension until June 30. The date itself is debatable already as EU insisted it couldn’t be later than May 23, when EU elections are held. The issue right now is that EU has given quite unified response that UK could be granted an extension only on condition that the Brexit deal is approved by the Commons.

In statement, Tusk offered to give short Article 50 extension. But that would be “conditional on a positive vote on the withdrawal agreement in the House of Commons.” If his proposal is approved by all other 27 EU members, and there is a positive vote in the House of Commons