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The Fed Playbook: For Now

Mid Week Bond Update

The Fed Playbook: For Now

Global Thought Leadership

Jul 18 2018

Fed Chair Jerome Powell’s July 17th testimony before the Senate Banking, Housing, and Urban Affairs Committee featured a slight, yet unmistakable shift in tone about the pace and level of future rate hikes...

In describing the risks to the Fed’s economic outlook as “balanced”, Powell said the FOMC’s belief that the best way forward is to keep gradually raising the federal funds rate – “for now”.

The phrase was more than a restatement of the standard disclaimer that Fed policy is based on the flow of economic data. The effect was to heighten the impression that the FOMC is in no sense on autopilot when it comes to rate hikes and other policies.

This matters because financial market observers have become fixated on the prospect of the U.S. yield curve becoming inverted, which has in the past signaled impending recession within 12 to 18 months.

 

Source: Bloomberg, July 17, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

The Fed has relatively little influence on the long-maturity 30-year part of the curve.  But Fed Funds rate hikes, combined with the pickup in issuance of short-dated Treasuries to fund increased fiscal largesse, have combined to drive the short end of the curve higher in 2018. Some observers believe that concern about inverting the curve could discourage the FOMC from raising rates as rapidly as previously planned.

If so, that would be a clear win for the “lower for longer” forecast for interest rates, and for investors who have positioned their portfolios accordingly.

Explore Western Asset’s case for the “lower for longer” outlook in CIO Ken Leech’s outlook: Global Recovery: Rough Waters Ahead?

On the Rise: Emerging Market Currencies

After a dismal first half of 2018, many of the EM currencies that attracted the most worry appeared to bounce back against the U.S. dollar.  As usual, each currency’s fall and rise had its own country-specific logic. Mexico continued its post-election optimism; Argentina benefitted from a new IMF credit line ; South Africa put some of its corruption-related political conflict behind it,.

On the downside, Turkey’s unruly domestic politics continued to take a toll as the independence of its central bank from government policy continued to be under threat from the increased powers granted newly re-elected President Erdoğan.

 

Source: Bloomberg, July 17, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

On the Slide:  Crude Oil

The supply and demand dynamics of the global crude-oil markets have pushed prices down since the end of June. Brent Crude traded at $71.89 per barrel as of July 17, down from its July 10th high of $79.35; West Texas Intermediate (WTI) traded at $67.75, down from its July 3 high of $75.02.

In addition, there’s been a notable shift in the price premium of Brent over WTI prices. As of June 7, the differential reached $11.37; since early July, the premium hovered between $4.00 and $5.00 per barrel. A likely explanation: the bottlenecks in bringing U.S. shale oil to market may have increased at the same time as Brent prices fell, driving Brent prices down at the same time as WTI became more difficult to ship.  Time will tell if Venezuela will recover its capacity, if Iran becomes more hampered by a reimposition of sanctions, or if the current uncertain nature of global trade will put downward pressure on overall demand.

 

All data Source: Bloomberg, July 17 2018, unless otherwise indicated. 

 

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