A look at the day ahead in US and global markets from Mike Dolan
There is little left to say about the main event of the day – except how the markets may react to the size of the Federal Reserve's interest rate cut later and what Fed policymakers are looking for on the horizon.
Few, if any, doubt that the Fed's first tapering of the cycle is now imminent. Wall Street hit a new mid-day high on Tuesday ahead of the decision – raising hopes for lower borrowing costs as the economy improves. Stock futures firmed overnight on the big decision.
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Last-minute economic tests as Fed officials convened showed retail sales rising sharply again in August and factory forecasts exceeding forecasts, confounding lower surveys of manufacturers last month.
Notably, the Atlanta Fed's 'GDPNow' model raised its third-quarter growth estimate by half to 3% later – in line with the pace at which the economy grew in the second quarter.
And despite strong market performance and economic recovery, futures still hinge on the Fed's 50 basis point cut on Wednesday rather than the usual 25bp move. With 40bp still in price, that puts the probability of a big move at 60%.
Former Fed economist Claudia Sahm on Tuesday was the latest Fed to call for a major 50bp rate cut this week – arguing that now is the time to act to prevent unnecessary job losses and ensure the central bank's two goals are met.
“This is a Fed that has been very far behind on the high-employment side of the dual mandate,” Sahm said.
So, in your face, the economy is humming with massive cuts coming and inflation is back in its box. Those who check the market almanacs see only good things in it.
It may be different this time, of course, but the average one-year return of the stock market after the Fed's first rate cut is roughly 5% even in recessions. And it's more than 16% when the cuts come without a recession at all – the most likely scenario now facing investors.
On the other hand, could the stock and bond markets now be upset if they don't get the 50bp cut in the futures market?
With that, we may need to see how the cut fits into the Fed policymakers' 'dotted structure' of future rate projections. Markets are likely to reverse the move quickly if they push for the full amount of easing in the upcoming meetings and express confidence in the economy.
Some think that signs of opposition to the 'conspiracy of the dots' could be significant – not least if it suggests that the Fed has cut less than some policymakers thought it should.
And then there will be attention to the so-called long-term dot, which was recently set at 2.8%. Since this is widely seen as Fed officials' assessment of a sustainable 'neutral' rate that does not stimulate or slow down the economy, it is important in calculating the Fed's cyclical rate.
Before we get there, the Treasury market has grown slightly – with the two-year yield back above 3.60% – more than 10bps above the two-year low reached on Monday. That's almost enough to hold the lows for the year so far and above 141 Japanese yen.
The yen was further strengthened by disappointing Japanese trade data that saw both exports and imports miss forecasts.
Stocks around the world are generally mixed to the positive, according to Wall Street futures.
With Europe underperforming, UK stocks lost some ground and the pound rose above $1.32 as the Bank of England is not expected to follow the Fed on Thursday – potentially leaving the second cut of the year until after the Labor government's first budget next month.
Underpinning that thinking, British inflation held firm in August but accelerated in the services sector that the BoE is watching closely. While headline inflation remained steady near the target of 2.2%, services inflation rose more than forecast to 5.6%.
But as of Thursday the main focus may be on the BoE's latest annual estimate of the balance sheet's bond issuance – which is widely expected to have a target reduction of 100 billion pounds over the next 12 months, as it did last year. A potential upside for the bond market, however, is that repeating that target could mean a 75% drop in effective gilt sales due to a large schedule of maturing debt that could expire automatically.
Canada on Tuesday had better news on inflation, with its CPI rate hitting the central bank's target of 2% in August – below the forecast and undermining expectations of a 50bp rate cut from the Bank of Canada next month.
Key developments that should provide additional guidance for US markets later on Wednesday:
* The Federal Reserve's Federal Open Market Committee announces a policy decision, with quarterly economic forecasts and Fed chairman Jerome Powell's press conference
* August US housing starts/permits, July TIC data on overseas Treasuries
* Brazilian central bank policy decision
* International Monetary Fund First Deputy Managing Director Gita Gopinath speaks in Ireland
* US company revenue: General Mills (NYSE:)
(By Mike Dolan, editing by Andrew Cawthorne; mike.dolan@thomsonreuters.com)
