With a 25 bps cut a lock on Wednesday, let’s shift the discussion to what happens next. If we get more cuts, as the market is anticipating, it’s because the economic data at best is not getting better and at worst because it’s weakened further. Of course if the data stabilizes or improves from here, we won’t get more cuts (certainly no hikes) and we’ll see a jump in longer term interest rates.
The stock market has clearly placed its chips on the soft landing scenario but that also implicitly assumes we won’t get many more cuts after Wednesday because if growth steadies, why would we need many cuts. If a soft landing doesn’t come and rate cuts can’t address that, the $64k question for stocks is at what point do market players shift to the reasons for the rate cuts rather than the rate cuts in itself. My crystal ball is not clear right now on how all this plays out but we are certainly not in Kansas anymore.
As for the story on Friday that the administration discussed how to weaken the dollar, if they choose to do so, they must understand how much we rely on the financial kindness of strangers. 1)As of Q1, the US current account deficit as a percent of GDP touched 2.4%, the highest since Q1 2013. 2)Trade deficits are rocketing higher which means we need all the help we can get to finance it via the US Treasury. Foreigners have already been cutting their ownership stake in US Treasuries so lets not disturb that further. 3)Foreigners own almost $20 Trillion of US stocks and bonds (all kinds) that won’t appreciate a forced depreciation of the US dollar. This number doesn’t include hard assets owned like buildings and businesses outright and keep in mind that trillions of European and Japanese money has come to the US to avoid NIRP in their regions, 4)the euro heavy dollar index and the trade weighted dollar index are no higher than where they were in 2015, notwithstanding being at the upper end of the recent range, and 5)Lastly, we are a consumer dependent economy where the purchasing power of the US dollar is very important. Importing inflation and weakening what the dollar can buy would more than offset the economic benefit to our exporters. Bottom line, it would be nonsensical to have a coordinated action to weaken the US dollar.
US DOLLAR INDEX
US DOLLAR TRADE WEIGHTED INDEX
The British pound continues to bleed which in turn helps the export dependent FTSE 100. We are now approaching $1.23. New PM Johnson is seemingly more than willing to leave without a deal as the EU doesn’t want to bend on the border issue with Ireland. I’ll argue again that regardless of how this plays out, messy or not, we’ll at least hopefully have a definitive answer by October 31st which then allow everyone to adjust.
BRITISH POUND