Jerome Powell’s semi-annual monetary policy testimony before the House Financial Services Committee continued the dovish tone of his June post-FOMC press conference noting that ‘crosscurrents, such as trade tensions and concerns about global growth, have been weighing on economic activity and the outlook’. In particular, this may be depressing business investment which ‘seems to have slowed notably’.
Importantly, Powell’s comments go on to suggest there has been no change in view since the FOMC and following the stronger than expected June non-farm payroll data: ‘Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.’ These comments in conjunction with the FOMC minutes (which were also released later that day) reinforce the case for a rate cut. The minutes note: ‘Many judged additional monetary policy accommodation would be warranted in the near term should these recent developments prove to be sustained and continue to weigh on the economic outlook’.
Having pulled back a little since Last Friday’s NFPR data, USTs rallied in response to Powell’s commentary with the yield on the UST 10 year closing the day at 2.05% having traded at 2.11% earlier in the day, although the 2s10s curve steepened. The market is now looking for at least a 25 bps cut at the July FOMC. We expect a 25bps cut and note that even the dovish St. Louis Fed President, James Bullard, who dissented in favour of a rate cut at the June meeting was talking along these lines yesterday: ‘I would argue for a 25 basis point cut at the next meeting’ and ‘I don’t like to prejudge the meeting too much, but if the meeting were today or tomorrow that is what I would be recommending.’
The UST 10 year yield is now trading a little above 2% but we see scope for it to trade below this level with a weak economic outlook. US dollar bonds remain relative high yielders compared to European and Japanese markets suggesting there is more scope for rate cuts and yield compression: at the time of writing the 10 year bund was trading on a yield of -0.28%. The inflation backdrop remains benign and the June FOMC projections showed a downward revision to the median estimate of core PCE inflation to 1.8% from 2% for 2019 and to 1.9% in 2020 from 2%. Moreover, Jerome Powell warned in his prepared remarks yesterday that ‘there is a risk that weak inflation will be even more persistent than we currently anticipate.’