10 Jun 2019

Fed Rate Cut Bets Drive Market Outlook

INR traded higher against the USD last week, helped by falling UST yields and change in June RBI policy stance from neutral to accommodative and cut in Repo Rate by 25bps.

author dp
Team INRBonds
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INR traded higher against the USD last week, helped by falling UST yields and change in June RBI policy stance from neutral to accommodative and cut in Repo Rate by 25bps. The INR has strengthened largely due to portfolio flows post elections in May. The INR can stabilize at higher levels but trade tensions and geopolitical issues will keep gains capped. INR appreciated by 0.33% against the USD last week and depreciated by 0.58% against the euro.

USD ended the week lower against major world currencies as a weak jobs report  elevated bets of a Fed rate cut. In May, Job creation slowed significantly and as per the Labour department, Nonfarm payrolls for May were  lower than expectations at 75,000 against the forecast of 185000 jobs. Wages inched up 3.1% yearly. Manufacturing added 3000 factory jobs. The unemployment rate came in at a 50-year low of 3.6%. Fewer jobs addition indicate broader economic weakness, boosting expectations for a US Fed rate cut. However, lack of labour supply is also a reason for lower than expected job creation, which could push wage growth upwards.

USD Index (DXY), which tracks the movement of the USD against six major currencies, declined by 1.22% on a week on week basis and is at a level of 96.54.

The Institute for Supply Management (ISM), an association of purchasing managers Index, reported on 5th June, Wednesday that its service index rose to 56.9 last month, up from 55.5 in April. Trump trying to impose tariffs on Mexican goods apart from proposed higher levies on Chinese imports can lead to pressure on US economy. The U.S. trade deficit decreased to USD 50.8 billion in April, exports fell USD 4.6 billion to USD 206.8 billion while imports declined USD 5.7 billion to USD 257.6 billion.

Euro appreciated against the USD last week on ECB indication of ready to act and use all the tools at its disposal if the economy warrants.

Weekly Global Bond Market Analysis

US 10-year benchmark bond yields fell by 6 bps, as the market expects job slowdown will force US Federal Reserve to cut interest rates. Nonfarm payrolls (NFP) rose by just 75,000 in May, far below the market expectations for 185,000, while wage inflation unexpectedly eased. Wage inflation grew just 3.1% on an annualized basis, dropping from the prior month reading of 3.2%.

Recently Federal Reserve Chairman Jerome Powell said the central bank is watching current economic developments and Fed will do everything to keep the near-record expansion going. Powell also said markets have been nervous lately over an escalating trade war that has spread from China and now could include Mexico. Fed does not know how or when these issues will be resolved, but Fed is closely monitoring the implications of these developments for the U.S. economic outlook and, as always, will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective.

Eurozone bond yields fell after the European Central Bank (ECB) said it would delay its first post-crisis interest rate hike until at least the middle of next year. ECB said in a statement that the governing council “now expects the key ECB interest rates to remain at their present levels at least through the first half of 2020.” ECB kept its primary interest rate tool  (rate on bank overnight deposits) at -0.40%, the main refinancing rate, which determines the cost of credit in the economy, remained unchanged at 0% while the rate on the marginal lending facility, the emergency overnight borrowing rate for banks stayed at 0.25%.

Germany 10-year benchmark bond yields fell by 5 bps, Portugal 10-year benchmark bond yields fell by 21 bps, Spain 10-year benchmark bond yields fell by 17 bps.

Japan 10-year benchmark bond yields fell by 2 bps, Japan long-dated bond yields fell to almost 3 years low after Bank of Japan  reduced buying in long maturities, as the BOJ keeps the 10-year JGB yield around zero percent, while keeping short-term rates at negative levels, many investors buy only longer-dated bonds, such as 30-year paper. The BOJ offered to buy a total of 240 billion yen of JGBs with more than 10 to 40 years to maturity, on its first such operation this month. BoJ said it would buy those bonds only thrice in June, compared with four times per month for the past six months.

Emerging economies 10-year benchmark bond yields largely fell last week.

Russia 10-year benchmark bond yields fell by 17 bps, Elvira Nabiullina, governor of the Russian central bank, said that the key interest rate is now above the neutral range and the central bank is ready to consider cutting rates in the near future.

South Africa 10-year benchmark bond yields rose by 1 bps after media reports suggest there is a dispute within the ruling African National Congress and the central bank over the economic growth.

Brazil 10-year benchmark bond yields fell by 31 bps, Indonesia 10-year benchmark bond yields remained unchanged, China 10-year benchmark bond yields fell by 3 bps, Australia 10-year benchmark bond yields fell by 2 bps.

US benchmark Junk bond yields fell by 3 bps to 6.39%, Euro benchmark Junk bond yields rose by 4 bps to 3.67%.