The Trade Week Ahead – One Last Time

January 6, 2019

By Evan Lucas,

The final full week of trading and final ‘the trading week ahead’ for 2018 this week, what a week to finish on – three of the top five largest central banks are meeting for the final time this year and will not meet again until February 2019.

The banks are The Bank of England, the Bank of Japan and the one that will impact markets the most over the coming 12 months the US Federal Reserve. Neither the BoE or BoJ are forecasted to move rates this week, the Fed, however, is, that isn’t what the market is likely to react too; it’s the economic forecasts and the future projections of the Federal Funds rate that will get the USD moving around.s

Over the past two and a half months, perma-bears would have us believe something in the US and the global economy has fundamentally changed – “growth is ending; a recession is coming”.

Their justification for this stance is reflected in this chart

The ‘kinked’ curve (the inversion between the 2-year and 5-year bond) – is a strong inflection point recession watchers. It’s the first time in nearly 6 years the 2yr-5yr spread has inverted the last time was the lead up to the Euro crisis – the idea is recession risk is coming.

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The larger recession indicator, however, is the 2yr and 10yr spread inversion when this inverts a recession is coming according to history. Over the past 40 years, every time the 2-10yr inverts a US recession precedes it in the coming 18 months.

Note; however, the 2-10 hasn’t inverted yet but at 15 basis points it’s so close you can touch it and a further 25 basis point rise on Thursday could push the spread over the line.

That does beg the question, will the spreads in the bond and corporate debt markets make the ‘data dependent’ Fed pause in 2019? Is rate hike trajectory about to ease? It will make the dot plot releases all the more interesting – and it will make DXY the biggest mover and shaker on a trade front this week.

This Thursday’s meeting is a lock for the 25bp rise based on the communication over the past 2 months here is a sample of the Board (all these are voting members)

• Chairman Jerome Powell: “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth.” From a Nov. 28 speech

• Vice Chairman Richard Clarida: “We’re at a point now where we really need to be especially data dependent. The economy is doing well. We’re looking for signals from the labor market, from inflation, to get a sense of both the pace and the destination for policy.” Interview on CNBC on Nov. 16

• New York Fed President John Williams: “I do expect further gradual increases in interest rates will best sponsor a sustained economic expansion.” Press conference on Dec. 4.

Vice Chairman Clarida is interesting – it’s the slight dovishness in the ‘especially’ that may give a hint to Thursday’s press conference – any signs of a pause or a slightly less hawkish Fed will drag on the USD and could mark the start of its moderation in 2019.

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