The equity markets bounced off their lows after the Federal Reserve kept interest rates unchanged and pledged to keep rates unchanged for an extended period. The S&P, which was down more than 11 points, close the session down 6 points to 1121.The FOMC voted to reinvest the maturing Agency and MBS securities into Treasuries, which is the type of asset purchases that some had been looking for. We had thought the Fed would refrain, but did not see it as having a major impact on yields or the economy. The dollar saw its earlier gains pared and the stock market recouped some of its earlier losses. The US Treasury market rallied in response. The Fed did lower its assessment of the economy as widely expected. The Fed recognizes that the economic recovery is likely to be more modest in the near-term than it had anticipated. It continues to anticipate subdued inflation “for some time”. Meanwhile Hoenig continued his dissent and objected to the policy action on grounds that the economy was recovering modestly, as the Fed had previously anticipated. In general the recycling of the Agency and MBS is the most important aspect of today’s statement. It gives the statement a more dovish cast than the parsing of the words would.
After nearly stagnating in Q1, Europe’s economy appeared to accelerate in Q2 and appears off to a good start in Q3 (according to the ISM data and Trichet’s assessment). Nevertheless, among many participants is the expectation that the European economies will slow again under the “triple tightening” in the form of fiscal and monetary policy and currency strength. Today France reported a 1.7% decline in June’s industrial output, nearly offsetting in full May’s 1.9% rise. The market consensus was for around a 0.1% decline. The UK reported a softening of the BRC sales (0.5% year-over-year vs 1.2% previously), perhaps as the World Cup spur faded. RICS reported the first decline in house prices in a year for the month of July today. There is some thought that in its Quarterly Inflation report tomorrow, the BOE may cut its growth forecasts. One of the early tells that the dollar’s decline was tiring, we suggested, lay in how the market responded to fundamental news. In recent weeks, the market appeared to have simply shrugged off poor euro zone data and generally ignored positive US data. The shifting rate differential story and the price action in response to disappointing European data are flashing cautionary signals to dollar bears.
China and the UK reported trade figures today. Both were better than expected. China reported its biggest trade surplus since Jan last year of $28.7 bln. In July imports actually fell 0.4% and this weighed on those countries that rely on exports to China. China’s exports rose almost 6% on the month and this may have been exaggerated by Chinese companies trying to beat the end of the an export subsidy scheme. As if to send a clear message that the larger trade surplus will not lead to renewed pressure on the yuan, the PBOC fixed it lower. The UK reported a GBP 7.4 trade shortfall, its smallest deficit since Feb. Sterling’s depreciation over the last couple of years has not appeared to help exports and one month a trend does not make, but exports rose 4.3% on the month and about 6.5% quarter-over-quarter. With imports rising a more modest 1%, there is new hope that the external account can begin contributing positively to UK growth.