UK Chancellor takes leaf out of Trump's playbook, as Powell hints at a pause

It’s been a busy evening with Jerome Powell speaking and the UK Chancellor’s inaugural speech at Mansion House, where BOE governor Andrew Bailey also spoke. Powell’s remarks have caused a sudden shift in US rate expectations and in the US treasury market.

Reeves takes a leaf out of Trump’s book at Mansion House

The Chancellor’s first Mansion House speech to the City of London hit all the right notes for her audience of bankers and financiers. She mentioned less regulation and said that the UK’s crackdown on banks in the aftermath of the financial crisis has gone too far. She promised to address this issue. She also announced a well-flagged plan to introduce new legislation that will allow the UK to merge 86 local government pension schemes into a handful of mega funds, that may invest in UK infrastructure.

We will be watching bank stocks closely on Friday, to see if Reeves’s talk about regulation boosts the UK’s financial sector. The FTSE 100’s financial sector rallied into the Mansion House speech and was higher by 0.8% on Friday. However, will Reeves’s Trump-style desire to cut red tape boost the stock market like the President elect has done in the US? The KBW US banking index reached a record high in the aftermath of President Trump’s win and has rallied more than 10% so far this month.

Close Brothers banking on Reeves for support in probe  

Close Brothers, the UK finance house at the centre of the auto finance probe, saw its share price rally 14% on Thursday in anticipation of Reeves’s speech. It is still lower by 73% YTD. If the market perceives that the new government will lessen the blow from any fall out from this crisis, then there could be further room for Close Brothers to recover.

Powell does a 360 in Dallas

Just one week since the FOMC meeting where Powell opened the door to further rate cuts, this week’s CPI report appears to have triggered an about turn from the Fed governor. The two key parts of his speech in Dallas on Thursday, were: 1, ‘The economy is not sending any signals that we need to be in a hurry to lower rates’, and he said that the US economy has been ‘remarkably good’. 2, Powell also said that inflation is not yet at the Fed’s 2% goal, which suggests that the central bank is refocusing its concern on upside inflation risks in the aftermath of Trump’s election win. It also suggests that the Fed could upgrade their forecasts for inflation at their December meeting.

Fed preparing for a pause

Powell was less tight-lipped during this press conference compared to last week. He said that as US rates approach a neutral level, the Fed must be careful and ‘slow the pace of what we are doing’. This explicitly opens the door to a pause, potentially as early as December, in our view.

The market has rapidly recalibrated their expectations for interest rates, there is now a 62% probability of a rate cut in December, down from 82% on Wednesday. The Market only expects a 27% chance of a rate cut in January, down from 32% on Wednesday. If US economic data continues to come in hot, and if the November CPI report, released the day before the next FOMC meeting, is above expectations then a pause in December could be on the cards.

From a market perspective, this means asset prices may become sensitive to the economic data that is released in the coming weeks. So far this year, in the 30 mins after a CPI release, the dollar index has had an upper bound response of 0.55%, and a lower bound response of -0.37%. This compares with an upper bound response of 0.13% in the dollar index in the 30 minutes after the CPI release in pre-covid 2019, and a lower bound response of -0.06%.  This suggests that financial markets are getting more sensitive to economic data and the Fed could over-take Trump as the main driver of markets as we lead up to the next FOMC meeting on 18th December.

The market impact of Powell’s speech has been a jump in US yields, the 2-year yield rose by nearly 6 bps late on Thursday. US stocks were lower across the board, and the dollar index has backed away from 107.00, although it remains in a strong position as we reach the end of the week.