Fed paves the way for monetary easing

The Fed walked the talk yesterday after its chair Powell signaled readiness to act earlier this month. The US central bank left rates stable (although Bullard dissented, voting for a 25 bp rate cut) but paved the way for rate cuts in the future. The FOMC's description of the US economy was less optimistic than in May as "cross currents reemerged". Increased uncertainties about the outlook and muted inflation pressures warrant close monitoring of incoming data. The Fed pledged to "act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective". This marked a clear shift from a neutral ("patient") to a dovish stance which is backed by the central bank's June forecasts. Growth projections barely changed vs. March but inflation is now expected to hit the 2% target only by the end of the policy horizon (2021). The new dot plot does not pencil in a rate cut before 2020 yet, but 2019 is a close call with 7 out of 17 governors expecting a 50 bps lower policy rate by the end of the year. The FOMC wants to wait and see how the identified risks weigh on the outlook. Powell said they did not engage yet on the size of a possible cut but could act "promptly" if needed, leaving open the case for both a 25 and 50 bps. Although the expected rate path is still a long way from what markets discounted ahead of the Fed, US yields suffered severe losses. They feel comfort in the Fed's dovish signal. The yield curve bull steepened with changes between -13 bps (2y) and -4 bp (10y). Markets now take a July rate cut for granted.Asian markets are profiting from the Fed's dovish tilt. China outperforms with gains up to 2.5%. US yields are extending yesterday's losses. The US10y yield slips below 2% (-4 bps). Losses for the shorter end of the curve are more limited. Japanese yields (-0.16% for 10y) suffer spill-over effects even as the BoJ left rates unchanged. Today's economic calendar (jobless claims, Philly Fed business outlook) provides markets with little inspiration. Both the ECB and the Fed will continue to reverberate through global bond markets. We expect the Bund to open higher in the wake of the Fed policy meeting yesterday, but don't forecast outsized gains. The test of key support in the US 10-yr yield is ongoing.

Long term view: The onus of the ECB is back on potential easing measuring including revamping asset purchases or cutting rates. The German 10-yr yield sets a new all-time low. There's no trigger available at this stage to escape the lows, let alone negative territory. The Fed opened the door for cutting rates. The US 10-yr yield is currently below, but still testing 2.01%. A break would point to more losses. The next high profile support is situated around 1.77% (76% Fibonacci retracement). There's probably little room for a rebound unless eco data start improving.

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