The Fed delivers the dovish goods, but no rate cut in sight

The reaction to this Wednesday’s Federal Reserve meeting has been muted at best. The Fed placated the doves and pledged its willingness and readiness to act to sustain the US economic expansion. This helped to push the S&P 500 up 0.3%, however, it was not enough to push this index above the record highs reached in April.

Draghi out-doved Powell 

Expectations had been building that the Fed was going to shift to a dovish stance, and this helped to fuel the rally in stocks at the start of June, however, after a mini sell off, the uptick in global stock markets earlier this week was not due to the Federal Reserve, but instead the dovish tone used by Mario Draghi, President of the ECB, at the ECB conference in Portugal. He signalled that the ECB would re-start its stimulus programme and it could cut rates further if the Eurozone economy continues to move at its sluggish pace. Interestingly, although Fed chair Jerome Powell spoke in a similar vein, his words have not had the same impact as Mario Draghi’s. Can this be explained by the greater faith investors’’ have in the longer-term prospects for the US economy, relative to the Eurozone’s? Investors may be more likely to believe that Mario Draghi, or his successor at the ECB, will actually have to follow through with stimulus measures because of the sclerotic European economies. In contrast, although the US economy is going through a rough patch right now, the outlook for the future remains fairly bright, thus Fed stimulus may not be necessary. 

Why the Fed may not cut rates any time soon 

This is one way to explain the fairly muted market moves in the wake of this much anticipated Fed meeting, Although the Fed lowered its inflation forecast for this year, the Personal Consumption Expenditures index is now expected to rise by 1.5% vs. 1.8% previously, the materials released with this Fed meeting do not suggest that the FOMC will cut rates imminently. Instead the Fed’s “Dot Plot” points to one rate cut next year instead, so stock markets may not be able to rely on Fed largesse for another leg higher. Due to the detail contained in the “Dot Plot”, we may see US stock indices give back some of this week’s gains as we move into the latter part of this week, as investors recalibrate their expectations about Fed rate cuts. 

Trade deals and G20 now in focus 

From a market perspective, the Fed meeting may have placated the doves, however, the lack of a firm commitment that a rate cut is coming means that the record high in the S&P 500 from April 30 at 2,945, remains a major level of resistance in the short term. Whether or not this level is breached may not depend on a Fed rate cut, instead traders will be looking towards next week’s G20 meeting, where expectations are rising that the US and China will sign a new trade deal and ditch the trade tariffs and war of words that have dogged global growth so far this year. If the US and China can sign a trade deal next week then a Fed rate cut may no longer be necessary, and global stocks may stage a fresh rally, possibly pushing the S&P 500 into new record-breaking territory. 

Why USD/JPY’s fate is to remain range bound 

Another sign that this Fed meeting will only have a fleeting impact on financial markets is the performance of USD/JPY. Although the dollar dropped across the board on the back of this meeting, the Fed meeting alone has not been enough to move USD/JPY out of its 108.00-108.70 range. At the time of writing, the market seems reluctant to test 108.00, which is a key psychological support level. The next test for this pair is the G20 meeting and the outcome of the US-China trade talks. If both sides agree to a trade deal then expect a major turnaround in USD/JPY, the first level of resistance is 108.70, which, if breached, could trigger a strong rally back towards 110.00. If no deal is signed and more tariffs are threatened by both sides, then we could see a breach of 107.65-70, the lows from January. 

Ahead today the BOJ and BOE are not expected to change their policy stance, however, the BOJ is likely to sound concerned about global growth and the slowdown in Japanese exports. Thus, as we move to the end of the week USD/JPY could see some of the recent selling pressure ease, although we continue to think that 108.70 will remain key resistance ahead of next week’s critical G20 meeting. 

Why Boris weighs on the pound 

The pound is already failing to hold onto gains from earlier on Thursday, as the market digests news that Boris Johnson is likely to become PM and the UK will be forced to leave the EU on 31stOctober, with or without a deal. The pound has an inverse correlation with Boris Johnson’s prospects of becoming the next inhabitant of 10 Downing Street. At the moment he looks like a shoo-in, which is likely to limit GBP upside during the summer months. 

Although GBP/USD capitalised on dollar weakness in the immediate aftermath of the Fed meeting, the rally was fleeting, and gains have already been given back at the time of writing.  We believe that GBP/USD remains a sell on rallies, and 1.2550 remains key support in the next 24- 48 hours. One caveat to this is the BOE meeting. In recent weeks there have been some BOE members who have said that a rate hike is as likely as a rate cut, which has been perceived as hawkish. If other members seem to be shifting to this stance then we could see a sustained bounce in GBP, but after a series of weak economic data recently, we believe that the balance of risks remain to the downside for sterling for the medium-term.