For the first time in a decade the Federal Reserve intervened in the US interbank market to remedy a drying up of overnight liquidity. This prompted speculation that Fed officials could announce a permanent facility to avoid such problems in the future.
Our view is that the injections of cash are aimed to ensure the proper functioning of the financial system, rather than signaling a change in the Fed's view of the economic outlook. Investors will be looking for further guidance on the Fed's policy outlook and views of the economy from today's meeting with a focus on the following:
- The rate decision: Markets are pricing in a high probability of a 25 basis points (bps) rate cut. But there is a widening spread of views among Fed policy makers. Close to half of the monetary policy committee did not support the 25bps cut in July. The debate on the committee will include both the possibility of a 50bps cut, along with no cut at all. Since the July policy meeting both doves and hawks will be able to point to developments to support their case. Hawks can point to a firm core consumer price index reading for August, with a year-on-year rise of 2.4%. Doves may look to the recent introduction of higher US tariffs on more Chinese imports, and the potential of continued trade uncertainty to slow corporate investment. The latest payroll data also suggested slower jobs growth.
- Rate forecast: The fracturing of opinion in the committee could also be reflected in the dot plot, in which members offer their projections. Here it will be important as well to observe whether the median committee forecast for the equilibrium neutral policy rate changes.
- Jerome Powell's tone: The Fed chair has recently struck a balanced tone on the outlook for the US economy. Overall, we expect Powell to signal that the Fed remains prepared to cut rates to insure against a slowdown in growth caused by trade uncertainty. Investors could be disappointed if Powell's comments in the press confidence point to a slower pace of rate cuts than the market is expecting. At present, the market is expecting 78bps of Fed policy rate cuts over the next 12 months.
With the Fed still in easing mode we favor tactical investment strategies that offer carry. We are overweight emerging market hard currency bonds, and in our FX strategy we overweight a basket of high-yielding emerging market currencies against a basket of lower-yielding currencies. We overweight the higher-yielding Indonesian rupiah and the Indian rupee, relative to the lower-yielding Australian and Taiwanese dollars.
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