Fed cuts IOER; soft inflation transient?

KBC Market Research Desk KBC Bank

Japanese (Golden Week), Chinese and most European markets (both Labour Day) were closed yesterday. The US trading session nevertheless turned out to be interesting. US Treasuries ignored a strong April ADP employment report (+275k vs +180k expected), but profited from an unexpectedly strong decline in the US manufacturing ISM (52.8 from 55.3 vs 55 expected). The April reading was the weakest since October 2016 with details (eg new orders and employment) showing more signs of softness. US Treasuries received a second push in the back after the Fed's policy rate announcements. The target bounds remain unchanged (2.25%-2.5%), but the Fed has cut the Interest Rate on Excessive Reserves (IOER) by 5 bps from 2.4% to 2.35%. Fed Chair Powell downplayed the significance afterwards at the press conference. It's mainly to avoid that the Fed Funds effective rate (weighted average of overnight bank rates) would surpass the upper end of the policy range. The effective rate gently increased to 2.45% in past sessions, which is the widest since the introduction of IOER (2008) and suggests a tightening of liquidity. US Treasuries hit an air pocket after Powell said that some of the reasons behind current low inflation appear to be "transient or idiosyncratic". The Fed wants to keep its wait-and-see attitude with currently no strong trigger to move rates in either direction. The US yield curve eventually flattened with yield changes varying between +3.8 bps (2-yr) and -2.5 bps (30-yr).

Most Asian stock markets are positively oriented this morning despite late WS weakness (up to-0.75%). The US S&P 500 shows a technical bearish engulfing signal, suggesting a short term trend reversal (correction lower). The US Note future trades near yesterday's intraday lows. The eco calendar only contains final EMU manufacturing PMI's, US weekly jobless claims and final durable goods orders. We don't expect the data to guide trading. The session could be a transitory one, bridging yesterday's Fed with tomorrow's US-non manufacturing ISM and payrolls.

Long term view: markets concluded that the ECB missed out on this cycle. They even start pondering the possibility of an additional deposit rate cut. The downtrend in the German 10-yr remains in place so far. Regarding Fed policy, markets now discount a >50% probability of a Fed rate cut by December. The US 10-yr yield earlier this month returned above the lower bound of the previous 2.5%-2.79%. This turned the picture more neutral again, but the move lacks conviction.

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KBC Market Research Desk

KBC Bank

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