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Weekly Talking Points

June 21, 2019

Yet another dovish turn of the screw by the Fed torqued markets further this week, despite a widening array of geopolitical concerns. While there were no major surprises in the FOMC announcement, the tone left little to the imagination that rate cuts beckon. Technically, the on-hold rate decision could have been a small disappointment, given that markets had priced in a reasonable chance of a rate cut for this meeting. Yet, even musings by Chair Powell on 25-vs-50 bps for the next move was raw meat for the bond bulls—and markets are now priced for roughly a 1-in-4 chance of a 50 bp slice in July. A slim majority of members have yet to pencil in cuts in their projections for 2019, but Powell (perhaps inadvertently) hinted that he had done so (“…some of us…”). We remain entirely comfortable with our call for two 25 bp trims in the second half, starting on July 31.

The Fed’s cooing followed hard on the heels of equally soothing remarks by the ECB. Mario Draghi asserted this week that monetary policy “does not resign itself to too-low inflation”, and that the ECB will “use all the flexibility within our mandate”. Another board member chimed in that he was concerned about the Eurozone economy, in a rather blunt assessment. On cue, May inflation in the Euro Area was confirmed at just 1.2% y/y, while core was clipped half a point to a mere 0.8% pace—both of which make the Fed’s low-inflation “problem” seem trivial. German yields pushed deeper into negative land, with 10s nearing -0.4%.

True, neither central bank actually did anything this week, but the double-dose of dutifully dovish dictums kept markets rolling. As we approach the mid-way point for 2019 (we are 47% through this year, but who’s counting?), the widespread theme has been the bullish market in almost everything, largely courtesy of the Fed’s pivot. After a challenging spell in 2018 for almost all asset classes, most have come roaring back to life this year—despite a clear cooling in global growth, and a bevy of concerns. To wit…
  • The S&P 500 closed at an all-time high on Thursday and is up a towering 17.8% YTD, looking past trade wars and clear signs of cooling growth.
  • The 10-year Treasury yield cracked below 2% in the wake of the FOMC, off more than 100 bps in little more than six months, looking past a wave of U.S. supply.
  • Oil popped 10% this week on friction with Iran and is up 26% YTD, looking past a wave of U.S. supply.
  • The Canadian dollar jumped 1.6% this week on firmer oil and a robust CPI, looking past the economy’s paltry productivity and bulging current account gap.
  • Goldgold!… advanced another 4% to a six-year high of nearly $1,400, looking past the lack of inflation almost everywhere.
  • BitcoinBitcoin!… has doubled in the past three months alone (confirming its reputation as a stable genius), looking past news of a new quasi-competitor from Facebook’s Libra.
The band plays on for markets even as the economic data have revealed increasing damage from the trade war. To this point, the damage has been most obvious in sentiment surveys, especially among manufacturers—as one could expect, when supply chains are being disrupted by tariffs. For instance, this week saw surprisingly deep pullbacks in regional factory surveys from both New York and Philly. The broader Markit PMI for manufacturers barely stayed in growth terrain at 50.1 for June, while the Eurozone’s similar result slipped to 47.8. Notably, services are generally faring much better, as consumer spending and employment remain broadly positive (looking past soft U.S. May payrolls). However, the test for the economy in coming months will be whether the latter can maintain momentum as trade/exports/manufacturing results continue to struggle.

Given our inherent caution on the U.S./China trade outlook, and notwithstanding the news this week that talks are resuming and the Presidents will indeed meet next week at the G20, we suspect the export weakness will seep into the broader economy. Fundamentally, that’s the reason we have U.S. GDP growth averaging just 1.6% over the next seven quarters, precisely half the pace of the past year. It’s also the primary reason we are not quibbling with the Fed’s dovish turn, even at a time when the equity market is at a peak and unemployment is at a trough.

Displaying its never-ending ability to zig when all else is zagging, Canada’s economy threw a curve with this week’s peppy CPI. In stark contrast to fading underlying inflation in much of the industrial world, Canada’s core measures all shot higher in May. The trimmed mean hit 2.3%, while fusty ex-food & energy rose 2.4%, both marking a cycle high.

We made the case last week that the bar for BoC cuts was very high for three reasons. To recap: 1) the starting point for rates is lower and well below what the Bank considers to be neutral; 2) the last thing the Bank wants to do is light another fire under the housing market, and there are already signs that some markets are stabilizing or even regaining strength; and, 3) core inflation is not below target. The CPI result pounds home the latter point.

Having said that, it is passing strange that Canada’s core inflation rate is above 2% and is pushing higher, while the Fed’s favoured measure is 1.6% and fading. Both are dealing with very tight job markets, Canada’s wage growth has been more modest, and the Canadian dollar is almost unchanged from year-ago levels. It’s likely that at least one of the main core measures of inflation is sending a false signal—the truth is probably somewhere in between; i.e., underlying inflation is actually reasonably stable at close to 2% in both economies.
Douglas J. Porter, CFA | Chief Economist | Managing Director, Economic Research