Invesco: The Fed opens the door to easing policy

21 June 2019 | Lewis Aubrey-Johnson – Head of Fixed Income Products

Bond yields have rallied strongly since Wednesday’s Fed meeting. At the time of writing the 10-year US Treasury yield is testing 2%. We are not adding duration risk at these low levels of yield. In the UK funds, duration stays low. In the Luxembourg based funds we have reduced duration slightly.

Wednesday night’s Federal Open Market Committee (FOMC) meeting marked a significant shift in the Fed’s thinking.  Although the Fed kept the target rate in 2.25%-2.5% range, in the statement it removed reference to being “patient” on rates and said “uncertainties” around its outlook have increased.

The key worries appear to be below target inflation, lower inflation expectations, trade disputes and global growth.  In the press conference that followed Powell said:

“In the weeks since our last meeting, the crosscurrents have re-emerged. Growth indicators from around the world have disappointed on net, raising concerns about the strength of the global economy. Apparent progress on trade turned to greater uncertainty, and our contacts in business and agriculture report heightened concerns over trade developments. These concerns may have contributed to the drop in business confidence in some recent surveys and may be starting to show through to incoming data.”

Financial markets are now pricing in a 100% probability of 25bp cut in July and 100bp of cuts over the next year. This is still way ahead of the Fed dots (aggregate estimates of future interest rates from the FOMC members) which are only pricing one 25bp cut by the end of 2020.

So when taken in context of Draghi’s speech* at Sintra this week, it’s clear that both central banks have clearly set the markets up for potentially quite significant easing.

The fact that trade disputes are at the heart of the slowdown makes it more difficult to assess whether market estimates are a fair reflection of the amount of easing we will see. However, we think that on balance, the now significant easing of US financial conditions that we’ve seen since December, combined with a relatively strong domestic economy (low unemployment and rising wages) means that the market is pricing in the most dovish outcome.  It’s hard to believe that the Fed means more than 100bps of cuts.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Important information

All data is as at 20/06/2019 and sourced from Invesco unless otherwise stated.

Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.