Noble Apex eNewsletter Issue 820- Implications of US mid-cycle adjustment

2019-08-06 07:17
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05 August 2019 Issue 820

Global Market Commentary


  • United States: Trump announced that it would impose a 10% tariff on the US$300 billion Chinese exports to the US starting from September 1. For the entire week, the Dow fell 2.60% to 26,485.01 points. The S&P 500 index fell 3.10% to 2,932.05. The Nasdaq fell 3.92% to 8,004.07.
  • Europe: The Bank of England kept interest rates unchanged. The Bank’s latest outlook still expected that the UK would successfully leave the EU. Over the week, the UK’s FTSE 100 index fell 1.88 percent, the German DAX index fell 4.41 percent, and the French CAC 40 index fell 4.4 percent. The STOXX 600 index fell -3.22% to 378.15 points.
  • Asia: Bank of Japan Governor Haruhiko Kuroda said the central bank would not hesitate to further implement stimulus measures. Over the week, the Nikkei 225 index fell 2.64% to 21,087.16 points. The MSCI Asia Pacific Index fell 2.75 percent to 155.59.


  • United States: American companies lowered their third-quarter earnings outlook, and the market worried about the outlook for the second half. For the whole week, the US 10-year bond yield fell 22 basis points to 1.845%.
  • Eurozone: British Prime Minister Johnson said that unless the EU leaders gave up the current Brexit agreement, he woult not start negotiations with the EU on Brexit. For the whole week, the yield on German 10-year bonds fell 12 basis points to -0.497%.


  • Oil Price: Affected by the Sino-US trade war, international oil price marked its biggest one-day drop in four years. Over the week, New York oil futures fell 0.96% to close at $55.66 a barrel.


  • USD: The US ISM manufacturing index fell to a three-year low, due to production slowdown and uncertainty in export markets. For the entire week, the Dollar Index rose 0.86% to 98.01.
  • China: China’s Ministry of Commerce spokesman said that the Chinese and US teams meet agin in September. For the whole week, the yuan fell 0.853% against the US dollar at 6.938.


Economic-related News

  • United States: US President Trump suddenly escalated the trade war with China and announced that he would impose an extra 10% tariff on the $300 billion Chinese exports to the US from September 1. He threatened that the tariff rate may increase to 25% if the Sino-US negotiations continue to be deadlocked.
  • United States: The Fed will cut the interest rate by 25 basis points and will end the balance sheet contraction in advance. Chairman of Fed Powell said that interest rate cuts are essentially policy adjustments in the cycle, rather than implying that it is entering into an expansionary cycle.
  • United States: The US trade deficit narrowed 0.3% monthly to US$55.2 billion in June, beating street consensus of US$54.6 billion, the US Department of Commerce announced.
  • Eurozone: The British government has allocated another 2.1 billion pounds for preparing no-deal Brexit, showing that Prime Minister Johnson will take a tough stance on leaving the EU with or without agreement at the end of October.
  • Eurozone: Eurostat announced that, eurozone’s PPI slipped for four months in a row in June with monthly drop extending to 0.6% (as compared with previous value of 0.1% decrease), dipping more than market expectation of a 0.3% decline. The yearly gain slowed down to 0.7% (as compared with previous value of 1.6%) while market had predicted a 0.8% climb.
  • Eurozone: After seasonal adjustment, UK’s construction industry PMI ended its two-month sliding trend and rebounded to 45.3 in July from the ten-year low of 43.1 registered in June, IHS Markit/CIPS data revealed. However, market had expected the figure to climb to 46.
  • Japan: Japan said that it is still planned to remove South Korea from the list of trusted export destinations due to national security needs.
  • Japan: According to Nikkei/Markit data, South Korea’s Nikkei Manufacturing Purchasing Managers Index (PMI) in July reflected further contraction in the industry, and the index continued to fall to 47.3 from June 47.5.
  • Australia: The Australian Bureau of Statistics announced that Australia’s Producer Price Index (PPI) in the second quarter of this year unexpectedly accelerated to 2% year-on-year. It ended the two consecutive quarters of slowdown, and the market originally expected to maintain a 1.9% rise in the first quarter.
China Market Commentary
Economic-related news
• Before committing to buy more US agricultural product in this week, China canceled 14,700 tons of US pork that was scheduled to ship this year and next year, which is the largest US pork order that China has cancelled since records began.
• The People’s Bank of China decided to increase the amount of sub-loan for small and micro enterprises by 50 billion yuan, focusing on supporting small and medium-sized banks to expand credit supply to small and micro enterprises.

Implications of US mid-cycle adjustment

As market expected, the FOMC cut its key interest rate by one-notch of 25 basis points, the first reduction since the financial crisis in 2008. However, market was disappointed as Fed Chairman Jay Powell shifted tone again from last June meeting. His comments calling the current move as a “mid-cycle adjustment to policy” rather than a start of a more aggressive cycle of monetary easing, suggesting that there could only be only one more cut unless there is a severe deterioration of economic data. Before the Fed meeting, markets were expecting two to three interest rate cuts by the end of 2019 plus another one to two cuts during the first half of next year, showing that there’s a big discrepancy from Powell’s latest comment.

Indeed, Mr Powell’s comment is true that a mid-cycle adjustment occurred before in Fed history. The last mid-cycle adjustment in an interest rate up-cycle (Feb 1994 – Jan 2001) happened in 1995 and 1998. In 1995, the Fed made three “insurance cuts” of 75bps that drive the interest rate down to 5.25% because of moderating inflation at that time. Then in 1998, the near collapse of hedge fund Long Term Capital Management (LTCM) threatened the financial system, together with the associated turmoil of Russia’s debt default have triggered the Fed took out insurance by enacting three cuts again. Later in June 1999, the Fed start hiking interest rates again by a total of 175bps until the interest cycle peaked at 6.5% in Jan 2001.

Figure 1. Mid-cycle adjustment in 1995 and 1998

Sources: Bloomberg, iFund/Noble Apex

The insurance cut on the above period is quite successful as a positive stimulus, which prevents a slowdown of US economy and the US GDP growth actually improves in the year after the cut. By cutting rates prematurely, the Fed wishes to use insurance cuts to restore investors’ confidence and sentiment. The size of the cuts is typically smaller, ranging from 50-75bps, which is in-line with the Fed’s dot plot currently as officials are not expecting to cut interest rate by more than 50bps over the next two years.

However, for an insurance cut today does come with its own set of risks too. Typically, the Fed need to lower interest rate by around 500 bps to help an ailing economy during a downturn. With current interest rate (at a range of 2.25% – 2.5%) at a much lower level than the previous cycles, using an insurance cut for now would essentially leaving the Fed with even less room to work with when the economy really does need lower rates. Another risk for an insurance rate cut for now is that if the Fed is underestimating the growth deceleration of US economy as well as the negative impacts from US-Sino trade disputes – which is the key difference between current Fed’s view and market consensus today. If that’s the case, the Fed would be liable for the US recession because of his late action for a more aggressive monetary policy.

Nevertheless, Fed’s relatively hawkish message are not welcomed by most investors with key major stock markets in the world have a sharp correction after the announcement. Asset managers are likely to stay cautious and reduce their beta given the uncertainty of interest rate direction, while historically Asia FX, especially the rate sensitive currencies (IDR, INR and PHP) has weakened following the precautionary cut and Asian stock markets generally underperformed.

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