A surprisingly dovish Fed leaves rates unchanged , sends dollar up

US policymakers reinforce grim assessment of economic outlook

KUWAIT: Markets were expecting to hear a somewhat positive note from the Federal Reserve meeting, hoping to see projections from policymakers that indicate a turnaround in the US economy after the shock of the coronavirus pandemic, with the jobs markets showing early recovery and a rally in equities.

Instead, Fed Chairman Jerome Powell and his fellow monetary policymakers reinforced their grim assessment of the country’s economic prospects for the coming years. Reiterating the need for a heavy dose of support from the regulator as far over the economic horizon as they can see.

The US Federal Reserve left interest rates unchanged, pledging to maintain its unprecedented stimulus until the economy “has weathered recent events”. Current expectations are for no rate hikes this year or in 2021. “We’re not thinking about raising rates—we’re not even thinking about thinking about raising rates,” Chairman Jerome Powell told reporters. The Federal Open Market Committee said it was “committed to using its full range of tools to support the US economy in this challenging time.” The bank has also opposed negative interest rates through opinions supporting such moves have grown. All but two Fed officials predicted its main interest rate would remain close to zero through 2022.

In December 2019, Fed policymakers said they expected the US economy to grow about 2 percent this year and the unemployment rate to remain around 3.5 percent. In the Fed’s meeting, they announced they now

expect the economy to shrink by 6.5 percent in 2020 and unemployment to reach 9.3 percent from 13.3 percent in May, before falling to 6.5 percent in 2021. “The path ahead for the economy is highly uncertain and continues to depend to a significant degree on the path of the pandemic,” Powell said.

Powell added that the Fed was considering “explicit forms” of forward guidance on interest rates and asset purchases, a part of its traditional crisis fighting toolkit. As well as an approach dating back to the 1930s involving targeting interest rates along the yield curve, he said that the usefulness of the so called “yield curve control” remained “an open question.”

Mixed data

Data released Wednesday revealed consumer prices in the US declined for a third straight month in May, dipping 0.1 percent last month following a 0.8 percent plunge in April. The report showed that demand remained subdued amid a recession caused by the coronavirus pandemic. Prices were mainly pressured by a 3.5 percent drop in the cost of gasoline, which followed a 20.6 percent drop in April.

Producer prices on the other hand showed a recovery in May as the index gained 0.4 percent against the previous month. The figure exceeded forecasts for an increase of 0.1 percent making economists look at it as a sign that the worst of the disinflationary impulse from the coronavirus crisis to be behind us. It is worth noting that the figure in April showed that producer prices were down 1.3 percent, the steepest monthly drop since 2009.

On the jobs front, the number of Americans applying for initial unemployment benefits totaled 1.54 million in the week ending June 6, the initial claims number was slightly better than forecasts of 1.55 million and down from 1.89 million in the prior week. The number of continuing claims remained above the 20 million figure, reinforcing the view that the labor market could take years to recover from the pandemic even as businesses re-open. The latest jobless claims report comes after data showed US employers unexpectedly added 2.5m Jobs in May, bringing the jobless rate down from 14.7 percent to 13.3 percent. However, even with the decline in unemployment, the US joblessness remains well above its peak after the 2008-09 financial crisis. Fed officials had warned of further job losses on top of those experienced in the first two months of the pandemic and cautioned that a full recovery may not materialize until the end of next year.

Market reaction

US stocks were starting to erase their losses in the beginning of the week after some tentative signs of recovery had been noted, investors also started to ditch the US dollar as they felt safer. This sentiment turned around after the Fed announcement which brought back risk aversion in full swing, stocks were in selloff mode for the past three days and saw their sharpest losses on Thursday. The Dow Jones Industrial Average tumbled 6.9 percent or 1800 points, its biggest one day drop in three months, and closed the week down 7.22 percent at 25,605.5. The S&P 500 Index saw the same trajectory, closing the week down 6.24 percent at 3,041.3. The US dollar traded higher on safe haven clouds, with the index ending the week up 1.42 percent at 97.319. The pound sterling saw a dip against the dollar with the cable closing the week at 1.2540, while the euro dropped to 1.1260. The movements came as a result of the Fed’s meeting in addition to a plethora of factors, including the fear of a second wave of coronavirus cases in the US, driving investors to seek safety in the US dollar in addition to the Japanese yen and Swiss franc.

Lagarde defends ECB

“The COVID-19 pandemic and measures to contain the spread of the virus have caused an unprecedented contraction of economic activity in the euro area,” Christine Lagarde said in a speech on Monday. The ECB President addressed charges by Germany’s constitutional court that bond purchases conducted to lift inflation in the past five years might have disproportionate side effects. She went on to defend the most recent moves made by the ECB, saying the latest decision to expand the emergency bond-buying program by 600 billion euros to 1.35 trillion euros is “overwhelmingly positive.” Still, the ECB expects an economic contraction of 8.7 percent in the euro area this year.

The eurozone’s largest economy saw industrial production fall by 17.9 percent in April following an 8.9 percent drop in March. The plummet came during the height of lockdowns for Germany, with the auto industry alone suffering a decline of 74.6 percent m/m. The figures are the worst on record, despite the country having a less severe epidemic than its peers.

UK economy faces drops

GDP figures from the UK showed that the economy shrunk by a record 20.4 percent in April, as a result of the coronavirus pandemic. The drop is by far the largest contraction since monthly records began in 1997 and follows the previous record drop of 5.7 percent clocked in March. The readings meant that by the end of April, the economy was about 25 percent smaller than in February. The decline exceeded the 18.4 percent contraction forecasted by economists polled by Reuters. The figure dwarfed the downturn of 200809 financial crisis, when the fastest contraction was a monthly fall of 1 percent in March 2009. It also exceeds the 6 percent cumulative output lost during the one and a half years of economic contraction during the financial crisis.

China trade surplus surges

China’s trade surplus surged to a record $62.93 billion in May following a $45.34 billion surplus in April. The figure marks the highest on record and came in well above expectations of $39 billion. Exports, devastated by demand though aided by an increase in medical-related sales, fell less than expected dropping 3.3 percent y/y in May. Imports on the other hand plunged 16.7 percent y/y, a sharper-than-expected drop which illustrates the pressure on global manufacturers as growth stalls. Commodities China buys and depends on such as crude oil, natural gas, and soybeans have declined significantly in price amidst the global pandemic. This led to a growth in China’s foreign exchange reserves to $3.1017 trillion by the end of May, from $3.0915 trillion in late April.

China’s economy took the bulk of the damage during the first quarter of 2020, shrinking 6.8 percent y/y. The government announced it would not set an annual growth target for the first time since 2002. Looking at US-China trade developments, many expect US President Donald Trump has no option but to stick with a Phase 1 trade deal for now – a relief for many investors.

China’s trade surplus soars, Japan GDP sinks

Drop in Japan’s GDP

Japan’s GDP contracted less than initially estimated for the first quarter of 2020. The economy shrank 2.2 percent annually, far better than the initial estimate of a 3.4 percent contraction. Still, Japan has experienced two straight quarters of declines and the expectations are even worse for the second quarter of 2020. Prime Minister Shinzo Abe ended the national state of emergency two weeks ago, slightly ahead of schedule, and is now focused on a swift economic recovery. However, a resurgence of the virus in Tokyo suggests consumer spending could stay subdued for some time while export markets also struggle to reopen.