The Fed needs a Draghi

global perspectives

August 1, 2019

Salman Ahmed, PhD

Chief Investment Strategist

The Federal Reserve cut interest rates for the first time since 2008 on Wednesday. The Committee decided to lower the target range for the federal funds rate by a quarter-point to 2-2.25%.

The press conference was a great example of what not to do when you are cutting rates after more than ten years. Federal Reserve Chair Jerome Powell looked unprepared, despite there being a clear indication on the line of questioning, given the context, and he offered a lot of tentative views and details which were not really needed.

The press conference was filled with sound bites which were open to misinterpretation as they had little relevance to current market pricing, which was already pricing in a mid-cycle easing. Rather, Powell spent a lot of time explaining why this not a recession-type cutting cycle (which the market already knows) but more to do with threats to a favourable outlook.

On the subject of threats, he emphasized a number of global developments and the pressure on capex. The trade war with China is simmering and this negative force is unlikely to go away anytime soon. As such, three more cuts still seem reasonable in coming months, but given long positioning and ample room for misintrepretation, we are likely to see some reversal in rates space and a rally in the dollar. President Trump’s reaction is set to be another important factor as he may add to negativity.

All in all, this was a very weak press conference, despite a solid and clear FOMC statement. We expect there to be some reversal before Fed speakers come in the coming days to clarify Powell-generated confusion. As such, Powell may have some lessons to learn from ECB President Mario Draghi, as the latter managed expectations expertly, despite not delivering on immediate easing promise.

Investment implications

In the short term, we expect the dollar to rally and there to be pressure on recent momentum trades such as gold
Beyond the course of the next few weeks, we expect retrenchment to underlying trend of lower rates, once the dust settles

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