Morning comment: Dovish Fed, Brexit farce, Aussie jobs & Kiwi GDP

Chris Scicluna
Emily Nicol
Mantas Vanagas

Initially yesterday Wall Street traded with something of a ‘risk off’ tone after President Trump remarked that he expects to retain tariffs on imports from China “for a substantial period of time” to ensure China complies with the terms of any trade deal that might be struck. But after the Fed’s post-FOMC messaging was considered more dovish than the market had expected, stocks then moved into the black for a brief period. The prospect that the Fed’s policy tightening cycle might now be over – not entirely consistent with the updated dot-plots, which still suggested at least one further hike over the next couple of years (see below) – saw Treasury yields shift sharply lower, with the 10Y rallying about 7bps to 2.53%. But the impact on the curve added to weakness in financial stocks, which eventually closed down 2.1% and led the S&P500 to a loss of 0.3% on the day.

The US dollar weakened against almost all counterparts, with the notable exception of sterling, which was even weaker following PM Theresa May’s provocative decision yesterday morning to seek only a three-month Article 50 extension at this stage. Nevertheless, her particularly ill-judged statement later yesterday evening, which will only have further angered the very MPs upon whose votes she will rely to have a chance of gaining endorsement for her deal in coming days, had little further impact.

In Asia, equity markets have been mixed today. But for the most part, investors seem to have been slightly more comforted by the Fed’s dovish pivot – notwithstanding the resulting weakness in the US dollar – than they were concerned by President Trump’s comments on tariffs. In China, the CSI300 closed little changed but the Shanghai Composite was up 0.4% in line with the gain on Korea’s KOSPI. But the Hang Seng was significantly weaker. Markets in Japan were closed for the Vernal Equinox holiday today.

Meanwhile, an initial Fed-driven rally in Australian bonds were temporarily reversed – and a rally in the A$ extended further – after it was revealed that Australia’s unemployment rate had declined unexpected in February, somewhat undermining the case for immediate monetary policy easing. Similar price action was seen in New Zealand where the Q4 GDP report appeared to be not as weak as investors had feared, with the composition of growth also providing some reassurance (more on the Antipodean data releases below). However, at the close the rally in the US Treasury market prevailed with the 10Y yield closing at 1.88% in Australia – just above the 2016 low-point – and at a multi-decade low of 2.00% in New Zealand.

Looking ahead, UK retail sales data this morning seem likely to be soft, while the BoE’s monetary policy is bound to be left unchanged when the MPC meeting concludes. Then all eyes should be on Brussels, as EU leaders meet to discuss Theresa May’s extension request. While May’s letter will – true to form – have significantly irritated EU leaders, we expect a short Article 50 extension to be granted, conditional on her gaining agreement in the House of Commons for her deal (or at least a variant of it) in coming days. But, on current trends, she will not find the Parliamentary majority that she’s seeking, and so later on next week EU leaders will very likely have to meet again to agree the longer extension that many would have been happy to offer today.

After another day of political madness in the UK – starting with Theresa May countenancing only a three-month Article 50 extension to accommodate a further Parliamentary vote (MV3) on her negotiated deal, and culminating in a horribly misjudged statement by the PM to the public angrily blaming MPs for blocking her Brexit – this afternoon EU leaders will decide what to do. While they will have been highly irritated by May’s antics, we fully expect them to agree an initial short extension (perhaps to late May, just before the European Parliament elections) conditional upon subsequent endorsement by the House of Commons of the Withdrawal Agreement. But we would also expect them to leave open the door to a further Summit later next week to discuss what to do if and when May’s deal is rejected once again.

Certainly, May currently appears on course for another defeat if MV3 is held over coming days, with her antagonism expressed towards MPs last night only likely to have strengthened the Parliamentarians’ resolve against her. So, while there are bound to be plenty more twists and turns to go, our baseline forecast is that the EU leaders will be back in Brussels next Thursday to agree a longer extension to the Article 50 deadline, which would then be reflected in legislation next Friday in time to avoid a no-deal Brexit. And there is a good chance that Theresa May will no longer be in position as Prime Minister to see that process through.

Clearly of second-order importance compared to the EU summit discussion on Brexit, today will also see the BoE announce its latest monetary policy decision. At February’s meeting the MPC left policy unchanged and reaffirmed its forward guidance that limited and gradual policy tightening will be required over the coming years if the economy evolves in line with expectations. However, Carney’s tone in the press conference was quite dovish, acknowledging that the outlook for the UK economy had deteriorated. With no new economic forecasts due at this point and with Brexit uncertainty weighing ever more heavily on the economy, MPC members will not want to make any adjustments to their policy stance at this point, so we expect today’s announcements to be uneventful. With regard to Brexit, a couple of external members of the Committee have recently expressed their personal opinion that, in a no-deal scenario, a cut to Bank Rate would be more likely than an increase. But not all MPC members are of a similar opinion. And while last week’s House of Commons votes significantly reduced the likelihood of such a disorderly Brexit, we would expect the Committee to reaffirm its readiness to change policy in either direction in such a scenario, depending on the balance of the impact to supply, demand and the exchange rate.

As well as the announcement from the BoE, we will receive the latest official data on retail sector activity. Surveys suggest that, after a stronger performance in January, growth stalled in February, as many retailers introduced new-season items at full price. So, having risen to a two-year high of 4.2%Y/Y in January, retail sales growth is set to have softened in February, likely to around 3%Y/Y.

As expected, yesterday saw the FOMC leave its target for the fed funds rate unchanged by unanimous vote. But the news of its plans for the balance sheet had been less predictable. In the event, the Fed announced that it will slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30bn to $15bn beginning in May, with the run-off to cease altogether in September. However, the Fed will allow its holdings of agency debt and agency MBS to continue to decline, consistent with the aim of holding primarily Treasury securities in the longer run. And from October, principal payments received from agency debt and agency MBS below the $20bn maximum amount will be reinvested in USTs.

In line with the post-meeting statement, the Fed’s revised Summary of Economic Projections (SEP) portrayed a slightly less optimistic view of the economic outlook than previously. The median participant now expects GDP growth of 2.1% this year and 1.9% next year (down 0.2ppts and 0.1ppts respectively), with growth forecast to slow further to an unrevised 1.8% in 2021 – 0.1ppt below the Fed’s unchanged assessment of the US economy’s long-run growth potential. The outlook means that the profile for the unemployment rate was raised by 0.2-0.3ppt across the forecast horizon, ending this year at 3.7% but stepping up to 3.9% by the end of 2020. The assumed long-term unemployment rate was revised down 0.1ppt to 4.3%.

As far as inflation is concerned, the Fed’s forecast for core PCE inflation would remain at an unrevised 2.0% each of the next three years. However, this is predicated on a materially lower path for the fed funds rate than was projected in December. Specifically, the median participant now forecasts no further rate hike in 2019, rather than the two hikes that were forecast previously. Indeed, 11 of the 17 participants now expect no rate hike this year – nine more than held this view in December. The median forecast calls for one hike in 2020, although seven participants expect no hike next year either. And with no further hike forecast by the median participant in 2021, the fed funds rate is now projected to end 2021 slightly below the unchanged long-term rate of 2.8%.

No FOMC member, however, is forecasting any rate cut over the horizon, but several are still forecasting several hikes. Nevertheless, in his post-meeting press conference Chairman Powell emphasized that the central forecast in the SEP was just one of a range of possible outcomes, with other scenarios – including more worrisome ones – also an input into the Fed’s policy deliberations. He repeated that the Fed believes it should be patient in assessing the need for any change in the stance of policy. For now, therefore, Powell argued that the data suggest no need to move policy in either direction. (Please see the attached note from Daiwa US chief economist Mike Moran for further discussion.)

Today should be less eventful for economic news from the US. Certainly, data-wise, today will bring only the usual weekly jobless claims figures, along with the release of the Philly Fed survey and Conference Board’s leading indicators for February. In the markets, the Treasury will sell 10Y TIPS. 

Euro area:
In addition to Brexit, the two-day EU summit, which gets underway later today, will see leaders discuss the future development of the Single Market, the Capital Markets Union and (perhaps contentiously) industrial policy, as well as climate change and preparations for the upcoming EU-China summit. Data-wise, this afternoon will bring the Commission’s flash consumer confidence indicator for March. This is expected to have posted another modest improvement for a third consecutive month, albeit still leaving the index on average in Q1 roughly ½ppt below the average in Q4. The ECB will also publish its latest Economic Bulletin, while in the markets France and Spain will issue bonds with various maturities.

The domestic focus in Australia today remained on the labour market which, according to the RBA, is likely to be the decisive factor governing whether the next change in monetary policy is a rate hike or a rate cut. In summary, the Labour Force survey for February provided no obvious support for the rate cut scenario first mooted by the RBA last month, which required a sustained rise in the unemployment rate to motivate an easing of monetary policy. Indeed, the unemployment rate unexpectedly declined 0.1ppts to 4.9% – albeit only just rounding down – marking the lowest reading since June 2011. Within the detail, growth in both employment and the labour force was a little weaker than market expectations – surprises that often go hand-in-hand and likely simply reflect monthly sampling variation (this variation tends to ‘wash out’ when calculating the unemployment rate). Specifically, employment was reported to have grown just 4.6k during February. This was not a great surprise considering that growth had averaged more than 30k over each of the previous 6 months – about double the long-term trend. Annual growth in employment still edged up to a very robust 2.3%Y/Y, nonetheless. Full-time employment fell 7.3k in February following a huge 65.6k increase in January, while part-time employment rebounded 11.9k after declining 27.3k last month. Meanwhile, the number of hours worked rose a solid 0.2%M/M and was up 2.2%Y/Y. Finally, the labour force participation rate edged down 0.1ppts to 65.6, bringing it back into line with the average reading over the previous twelve months.

New Zealand:
The main focus in New Zealand today was on the national accounts for Q4. The headline production-based measure of real GDP rose 0.6%Q/Q – bang in line with market expectations but 0.2ppts below the estimate made by the RBNZ in February. Annual growth slowed to 2.3%Y/Y – about ½ppt below the RBNZ’s estimate of trend growth and slightly below market expectations (that said, cumulative revisions to the level of GDP in Q3 amounted to less than 0.1ppts). The expenditure-based measure of real GDP increased 0.5%Q/Q and 2.5%Y/Y. Meanwhile, real gross national disposable income – which better represents resident’s purchasing power – fell 0.2%Q/Q in Q4 and increased just 1.7%Y/Y, weighed down by a decline in the terms of trade.

Nonetheless, the detail of the expenditure series indicated that private consumption rose a solid 1.3%Q/Q in Q4 – the third consecutive quarter where growth has been 1.0% or higher. The news regarding both residential and business investment was also positive, with the former rising 2.1%Q/Q and the latter rising 1.3%Q/Q (plant and machinery investment increased 2.0%Q/Q). Public sector consumption grew 0.7%Q/Q. Net exports also contributed positively to growth, with exports rising 1.1%Q/Q while imports fell 0.7%Q/Q. However, inventories and the seasonal adjustment balancing item – the latter capturing the difference between the directly adjusted aggregate outcome and the separately-adjusted expenditure components – subtracted a net 1.2ppts from growth. The production-based series reported a strong 0.9%Q/Q lift in activity in the services sector, but goods production increased just 0.2%Q/Q – in part due to disruptions in the energy sector – and primary sector production fell 0.8%Q/Q. Nominal GDP rose 0.3%Q/Q and 2.4%Y/Y. Finally, it is worth noting that the population grew 1.9%Y/Y in 2018, so in per-capita terms real GDP grew 0.9%Y/Y for the calendar year.

While today’s growth outcome was slightly weaker than the RBNZ had projected in the February, the report should have no more than a modest impact on the RBNZ’s messaging at next week’s Interim OCR Review. Rather, the short statement accompanying that review will likely dwell more on the outlook for growth this year and beyond. That outlook appears less favourable given continued concerns and uncertainties related to the global economy, as reflected in the more dovish stance taken by all major central banks in recent months. However, the RBNZ will most likely retain its fully neutral policy stance, pending a full review of the economic outlook at the following Monetary Policy Statement meeting in May – also the first meeting that will take place with the new MPC decision-making structure in place.

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