Brief Macro: The Dollar IS the Story; Gold Confounds, A Brexit Rabbit Hole; EUR Punished and more

In this briefing:

1. The Dollar IS the Story; Gold Confounds, A Brexit Rabbit Hole; EUR Punished
2. The Fed Is Increasing Financial System Fragility
3. Fed Policy Credibility: Financial Markets Raise the Heat
4. Japanese Inflation – Much Ado About Nothing
5. Philippines: No Dovish Pivot in the Monetary Board’s Latest Meeting

1. The Dollar IS the Story; Gold Confounds, A Brexit Rabbit Hole; EUR Punished

• The dollar IS the story
• EUR punished for negative yields
• Chasing Brexit down a rabbit hole
• Gold confounds
• Bitcoin at an interesting juncture

The fact that the dollar has strengthened despite the dovish turn at the Fed this year and the significant fall in US rates and bond yields has confounded many analysts.

2. The Fed Is Increasing Financial System Fragility

While the Fed and Treasury stabilized and strengthened the financial system following the financial crisis we think recent decisions by the Fed are increasing the risk of future instability.  The Fed’s efforts to manage market volatility are potentially counterproductive and there are risks to addressing liquidity via abundant reserves concentrated at a few large banks.  Researchers within the Federal Reserve systems have raised concerns but policymakers appear to be discounting these warnings.

3. Fed Policy Credibility: Financial Markets Raise the Heat

The Federal Open Market Committee (FOMC) sought to further mitigate the fallout from last December’s rise in the federal funds rate by ignoring its own economic models, and, instead, embracing a more dovish outlook for the policy rate, as well as slowing the planned pace of its balance sheet roll off.

No further interest rate increases are envisaged by the FOMC in 2019, while any required in 2020 will not take policy settings into restrictive territory due to the imminent arrival of sustainable growth.

The persistently low inflation backdrop has permitted the Fed to embrace a dovish approach, but engineering a significant decline in real interest rates could prove problematic if the economy falters at some future point.

Fears about yield curve inversion and recession risks persist, despite the Fed’s dovish tilt, thereby potentially raising concerns about the overall credibility of monetary policy conduct.

US short-term interest rates are being anchored to a “new normal” environment of low inflation and slower economic growth compared to history, and, consequently, the bond market appears to have won its battle of wills with the FOMC by forcing members to reduce their estimate of the neutral federal funds rate.

4. Japanese Inflation – Much Ado About Nothing

Japan’s policymakers continue to fret about the lack of inflation but it is worth remembering the norm globally and historically is for the price of manufactured goods to decline over time. As companies grow, specialise and scale up the cost of production falls and with it final consumer goods prices. Falling retail prices which increase consumer real purchasing power is good news for Japanese households and for discretionary spending. Moreover with labour productivity growth outpacing wages costs by a wide margin, companies can absorb lower prices without sacrificing profitability. Stay overweight Japanese equities.

5. Philippines: No Dovish Pivot in the Monetary Board’s Latest Meeting

• The anticipated cut in the bank reserve ratio didn’t materialize in the latest Monetary Board (MB) meeting–the first one chaired by newly appointed BSP Gov. Benjamin Diokno. In the ANC televised interview, Diokno expressed his preference to reduce the high bank reserve requirement ratio (RRR: 18%) by 1% every quarter, fueling bond market excitement that severely compressed yields. The policy rate was also unchanged amid the dovish tone in the BSP’s press release after the meeting.

• According to a senior monetary official, the RRR cut is a ‘live’ issue. That the timing of any adjustment is key given the operational and policy implications of an RRR cut.

•  Accentuating the MB’s depiction of benign inflation is an inflation trajectory settled comfortably in its target band in 2019-20 with inflation expectations close to being anchored within the band as well.  Key downside risk to growth cited by the MB is the ‘current budget impasse in Congress is not resolved soon’. Prolonged El Niño is among those factors that can upset the broadly balanced risks to inflation.

• A BSP under a pro-growth BSP chief need not necessarily change the ‘sequencing and timing’ of monetary policy decisions/actions facing liquidity and growth challenges. Likelihood that 1Q GDP (May 9 release) may be given slight emphasis in the BSP’s shift to accommodation starting with the bank reserve cut.  
• We expect a bond market correction following excitement over the BSP’s dovish pivot this early that led to severe yield compression. Buy the 5yrs to short-duration on dips.