Trick or treat? US/ China trade deal spooks markets, as NFP shocker could hurt dollar

Markets didn’t really no how to take the FOMC decision last night. Initially, the markets rejoiced at the news that the Fed had cut rates, however, the statement was slightly more hawkish than expected, after the phrase that the Fed “will act appropriately to sustain the expansion” was removed from the statement that accompanied last night’s decision. There has been much rumination about whether this was a “hawkish cut”, the fact that chairman Powell sounded more optimistic that the US/China trade deal would be resolved, and that a no-deal Brexit was likely to be avoided, suggests that this could be the end of the Fed’s rate cuts for 2019. The market agrees, and according to CME’s Fedwatch tool the market now expects a 22.9% chance of a rate cut at the December meeting, down from more than 27% chance this time last week, which is one reason why the S&P 500 dipped at the end of Wednesday’s session. 

Unpredictability of the Fed makes S&P 500 future uncertain 

However, do you remember we called the Fed’s September rate cut a “hawkish cut”, and yet they continued to cut rates in October. So, what will happen next? Can we actually trust what the Fed will do next? We would point out that the most dovish member of the FOMC, James Bullard, who voted for a 50bp cut last time, only voted for a 25bp cut this time, and there were two dissenters again at this meeting. Thus, on aggregate, the FOMC could be moving to a more neutral stance at the next meeting in 6 weeks’ time. However, the movement in the S&P 500 has been limited to say the least, and at the time of writing the US index has staged a mini recovery, but life above 3,000 remains laboured, and the outcome of Friday’s payrolls report is likely to be the next key driver of this index. 

GBP and euro could be beneficiaries of dollar malaise 

The unpredictability of the Fed is also replicated in the performance of the dollar index. The dollar index jumped to its highest level this week on the back of the Fed decision, however, the rally faded just before 98.00, and dropped 80 pips, before picking up 20 points this afternoon. The dollar remains close to the lows of the month, the lowest level of the last 4 weeks was 97.10, and the Fed’s “hawkish cut” on Wednesday hasn’t helped to change the dollar’s general malaise. This suggests to us that the dollar will remain under pressure for the medium-term, which gives the pound and the euro time to catch up. GBP/USD has backed away from $1.30 in recent days and reached a low of $1.2925 earlier on Thursday. GBP/USD has picked up from these lows and could have some more short-term upward momentum as long as the dollar remains muted. We would, however, urge caution around the pound as the outcome of the December 12th election remains up in the air. We would expect that the next major driver of the pound will be the latest polls, which could be released this Sunday. Any sign that the vote is being split, and the Tory majority is being eroded could weigh on GBP in the short term. 

Elsewhere, the euro could also be a beneficiary of USD weakness. EUR/USD dropped 40 pips after the FOMC announcement, but has since picked up, the next challenge for this pair is $1.1180, if it can break above this level then a return to the $1.1250 highs from August could be on the cards. We are not predicting a huge short-to-medium term range for this pair; however, the bias could be higher for EUR/USD in the short term. 

The three key drivers for markets in the short-term 

The ultimate direction of most markets in the next couple of days is likely to come down to three things: 1, any further updates about the US/China trade deal. 2, the outcome of the October NFP report, and 3, the latest UK election polls. The US/China trade deal has been the main market driver today. Firstly, the Chinese sounded doubtful that a deal is in the mix, after saying that they don’t trust Trump’s decision making. However, the latest update is that President Trump and his Chinese counterpart will sign a deal amounting to 60% of the trade deal at an upcoming summit. The fact that the S&P 500 remains above 3,000 suggests that the market is fairly confident a deal will be struck, however, any signs that the deal will be held up could weigh heavily on US stocks and risky assets more broadly. 

NFP shocker, when bad news is good for stocks 

The NFP report is also a key driver of the markets in the short term. The bar is extremely low for this month’s report, the average economist estimate is 89k, which would be the lowest level since May. NFPs have been trending lower in recent months, and we could see the unemployment rate tick up from 3.5% to 3.6%, any larger jump than this could trigger some fear about the US economy, which in turn could boost expectations for further rate cuts from the Fed and actually help US stocks, rather than hinder them. US wage growth is expected to remain solid at 3%, however, the ISM manufacturing report for October, which is set for release later tomorrow afternoon, is expected to pick up slightly from 47.8 to 48.9, which would still be in contraction territory. As with a weak NFP, a weaker ISM reading may weigh on the dollar and boost stocks, as bad economic news becomes good news for the stock market if it increases the chances of further rate cuts from the Fed in the coming months. 

Why the election is all that matters for the pound in the coming days 

The last major driver of markets in the short term could be any further opinion polls on the UK general election. This could be the key driver of the pound at the start of trading next week. We would expect any sign that the outcome of the election is becoming less certain to weigh on GBP, while a wider margin of victory for the Conservative party could boost GBP at the start of next week, potentially pushing GBP/USD back above $1.30.