The sudden stress in U.S. dollar funding markets in recent days has spooked people by stirring memories of the 2008 crisis. A rocketing repo rate — the key measure of liquidity in the global banking system — and a jump in the U.S. Federal Reserve’s target interest rate to levels not seen since 2008 forced the New York Fed to intervene four times to maintain the Fed funds rate in the 1.75%-2.0% range.
It is unclear yet whether the tightness was a one-off, triggered by technical issues such as Treasury maturities and tax payments, or if there’s a systemic issue waiting to roil global markets.
So far there’s no sign of spillover overseas but investors are on the watch for any warning signals, given the dollar’s dominance in cross-border trade and investment. For instance, cross currency euro-dollar swaps, effectively a reflection of dollar funding costs for offshore investors, are nowhere near levels seen even during last October’s selloff, let alone during the 2011 euro debt crisis. This is where non-U.S. banks would go to source dollar liquidity if they find themselves shut out of U.S. money markets.
If the repo chaos continues into coming days, offshore markets are likely to start feeling the heat. Watch this space.
AND THEN THERE WERE NONE…
After the U.S. Fed’s second “insurance” rate cut of 2019, officials’ median rate forecasts hint at no more cuts this year. The shift has come as a shock given expectations prior to the Fed meeting were for several more cuts to contain the impact of U.S. President Donald Trump’s tariff tussles with China.
The Fed judges the U.S. economy can get on fine without further short-term stimulus. Upcoming data may show us whether that view is accurate or if, in chairman Jerome Powell’s words, “a more extensive sequence of rate cuts could be appropriate”.
August durable goods orders will shed light on whether the trade war is eroding business investment. Orders for goods such as airplanes and toasters are seen having fallen 1% after rising 2% in July. Of keen interest will be orders for non-defense capital goods, excluding aircraft — a closely watched proxy for business spending plans that increased 0.4% last month, even as shipments posted the biggest drop since October 2016. Core capital goods shipments are used to calculate GDP.
New dot-plot projections show Fed policymakers at the median expect rates to stay within the new 1.75%-2.00% Fed funds range through 2020. Futures traders, meanwhile, see a better than 50/50 chance that the target rate will be another 25-50 bp lower by the year end. They will be watching for comments from Fed policymakers due to speak at various events in coming days.
Britain’s Supreme Court has concluded hearings on whether Prime Minister Boris Johnson acted unlawfully in suspending parliament for five weeks and a ruling is due in coming days. A decision against Johnson may force him to recall lawmakers, giving them more time to challenge his plan to take Britain out of the European Union on Oct. 31 — with or without a divorce deal.
In fact, markets’ mood has improved of late, first of all as parliament passed a law to avert a no-deal Brexit by end-October. More recently, comments by EU Commission President Jean-Claude Juncker stirred hopes of a Brexit deal, sending the pound to its highest level since July and putting it on track for its best month this year.
There are positive noises from Ireland too, with Foreign Minister Simon Coveney acknowledging an improvement in “mood music”, though he and Brussels have stopped short of saying a deal is within reach. An EU diplomat in fact described documents submitted by London as a “smokescreen”. So crashing out of the EU still remains an imminent possibility.
Meanwhile, the government has said it will abide by the Supreme Court’s ruling. If that comes to pass, it could be the catalyst for the next leg of sterling’s recent rally.
While the Fed has been talking up the state of the U.S. economy, ECB chief Mario Draghi has urged euro zone governments to step on the fiscal gas pedal if they want to see economic growth speeding up.
Given that background and the Fed’s promise to be “highly data-dependent” while setting interest rates, flash Purchasing Managers’ Index (PMI) readings are likely to be closely scrutinized — a strong number would tip the balance in favor of the hawks on the Fed board.
The ECB on the other hand has already pledged indefinite stimulus and looking at depressed activity across the bloc, that seems justified. A positive PMI surprise would of course be highly welcome but a negative reading could be what’s needed to chivvy tight-fisted governments into spending more.
Australia and New Zealand have been locked in a dance of alternating rate cuts this year as the zest of two of the globe’s better-performing economies stales.
Markets are scrambling to price in extra easing on both sides of the Tasman Sea following a weak reading on Australian joblessness, which the Reserve Bank of Australia (RBA) says is crucial to its outlook. RBA chief Phil Lowe will speak on Tuesday, while the Reserve Bank of New Zealand meets in Wellington on Wednesday.
Markets don’t expect RBNZ chief Adrian Orr to move rates this month. But then, they hadn’t expected his 0.5% cut in August.
The bigger picture though, is that rates are heading downward. New Zealand’s economy is growing at its slowest in six years and Australian growth is at a decade-low. All of Australia’s big four banks have now brought forward rate-cut expectations. That’s a lot of doves to feed.