Fed Chair Jerome Powell boosted risk assets this year by signalling that he was not going to hike rates according to his ‘auto pilot’ policy. However, recent US job data has emerged that suggests the US is in a far better position to hikes rate then was thought. Fund managers now are concerned that the continued loose monetary policy signalled this year, if reversed, could end what has been a prolonged bull run for equities.
The surprisingly upbeat US labour market report for June has already caused the market to price out a double interest cut this month. It was perhaps Mr Powell’s statement that monetary policy would be ‘data driven’ that has spooked the markets as surprise data should have a profound impact on policy.
By implication, a strengthening US labour force has also made a US recession look more unlikely and also caused bond yields to spike, adding pressure to fixed income investors seeking capital appreciation.
What a difference the release of the job data has made. Before it was released, Keith Wade, senior economist at Schroders, said the market was pricing in a rate cut of 75 basis points by the end of the year adding that bond yields had fallen significantly. The amount of assets in negatively yielding bonds hit $12.5 trillion, surpassing 2016’s peak.
Janet Mui, Global Economist at Cazenove Capital, after the release of the jobs report said: “It [job data] will reassure the Fed that the US labour market remains in good shape and no urgent or aggressive monetary easing (e.g. rate cuts) is needed at this point.”
However, she added that , the Federal Open Market Committee ‘may still view an “insurance” cut of 25 basis points as justified just in case the economy deteriorates. This is because of prolonged trade tensions and pockets of weakness in the economy, for example in manufacturing’.
Crucially Ms Mui said that sell-side analysts’ expectations of a 50 basis points rate cut is now ‘off the table’.
With other major central banks such as the ECB signalling they will maintain a dovish stance and keep monetary policy loose, any more divergence or policy reversals by the US is likely to create more volatility in the equity markets as seen last year. Also a strengthening of the dollar could have serious implications for regions such as emerging markets which tend to suffer when the dollar appreciates.
