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Odds up for larger Fed, ECB rate cuts
It has been a wild week for the global markets, as the dovish central bank expectations went through the ceiling following the escalating trade tensions between the US and China. The Reserve Bank of New Zealand opted for a surprise 50-basis-point cut (vs 25bp expected) to deal with the slowing global economy, the Reserve Bank of India lowered its rates by unprecedented 35 basis points and the Central Bank of Thailand surprised by a 25-basis-point rate cut.

The People’s Bank of China fixed the yuan rate weaker than the 7 mark for the first time since 2008, despite being subject to accusations for manipulating its currency from the US President Donald Trump. But the selling pressure on yuan eased after the data revealed that the Chinese exports grew 3.3% in terms of US dollars in July versus 1.3% fall expected by analysts. This equals to 10% growth in export revenues in terms of Chinese yuans last month. As a result, China’s trade surplus narrowed to $45.06 billion in July from $50.97 billion, versus $42.65 penciled in by analysts. Chinese trade surplus against the US expanded by 11.1% between January and July, exports to the US eased 2.1% during this period, while imports from the US dived 24% on worsening trade war between the two countries.

Rising odds of larger rate cuts from the Fed and the ECB

Tumbling Chinese demand for US goods could translate into weaker company results in the US. Hence, investors turn to the Federal Reserve (Fed) for more support.

Expectations of a September rate cut from the Fed is now fully priced in the US sovereign bond markets. FOMC members voice divergent opinions after the quick escalation of tensions with China. While St Louis Fed President Bullard kept his view that one more rate cut would be enough for this year, Chicago Fed President Evans said that the latest developments may require more policy easing in the coming months. Fed policymakers know that they don’t need to signal a rate cut twice. The US 10-year yield fell shortly below the 1.60% mark before rebounding to 1.74% in Asia, but the US dollar remained offered against all G10 currencies.

In Europe, the German 10-year yield dived to -0.58% as the odds for a European Central Bank (ECB) action in September topped at 100% as well. While majority of investors expect the ECB to lower its deposit facility rate by 10 basis point to -0.50% in September, few started betting on a 20-basis-point cut. The probability of a 20-basis-point cut stands at 12% presently. The EURUSD remains bid above the 1.12 level, given that the ECB has a narrower margin for lowering its rates compared to the Fed. The euro weakened up to 6.67% against the US dollar since September 2018. Hence, if the central banks race with each other to lower their rates, then the ECB may need alternative policy tools to prevent the single currency from recovering too quickly against the greenback. On the other hand, ECB’s asset purchases via another round of TLTRO (targeted long-term refinancing facilities) will inevitably continue weighing on euro area’s sovereign yields.

While investors continue pouring in the global debt markets, the stats become increasingly worrying. Today, $14.5 trillion worth of worldwide sovereign bonds pay negative interest rates. The negative yielding bonds represent a quarter of the global debt market, as the negative yielding bonds have been multiplied by three since October 2018.

Equity gains timid after surprise rate cuts, gold finds buyers below $1500

The cooperative action from the central banks cooled off the selling pressure in the equity markets. Asian equities gained after the major European indices closed Wednesday’s session in the green. The VIX eased 3.37%. US equity futures edged higher in Asia.

WTI crude rebounded 3% as Saudi Arabia said it is considering all options to halt the fall in oil markets after prices slid more than 17% since mid-July. There is a rising possibility for a tighter production regime from OPEC and its allies to match the expectations of a slower global demand.

Gold rebounded as fast as it slipped below the $1500 an ounce in Asia, as sovereign bond yields slid to fresh historical low levels. Gold purchases for hedging purposes are rising as well, as gains in equity markets are driven by a dangerous upsurge in central bank expectations and less by economic and company fundamentals. Higher share prices mean that companies should achieve higher earnings in the coming quarters. Hence there is complete reliance that additional rate cuts would spur the economic activity, but the major economies’ interest rates are already at historical low levels. The risk is that the additional rate cuts would have a marginal positive impact on economic activity and if the global demand continues waning, the rally in equity prices would remain unsupported, meaning that there could be a sharp downside correction in prices.

But for now, investors continue chasing dip buying opportunities. FTSE futures (+0.85%) hint at a positive start in London. Energy stocks could follow up on Asian gains, as WTI crude trades 2.96% up and Brent crude recovers 2.72%.

Goldminers are expected to extend rally on solid rise in gold prices. Fresnillo could enter the bullish consolidation zone if its price clears the 705p resistance, the major 38.2% Fibonacci retracement on July - August fall.


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