Markets pause before Fed, Brexmas election eyed

Morning Note

A blow off top or just a moment to pause ahead of the Fed; either way the S&P 500 edged back from its all-time high to close down marginally on Tuesday. Asian markets have broadly followed the lead. Coming off a dip yesterday, European markets were flat to slightly lower at the open with the FTSE just a little under 7300 and the DAX holding above 12,900. Bonds remain pretty stable with bunds at -0.35% and US 10s at 1.83%.

Markets are in wait-and-see mode as we await the outcome of the FOMC meeting tonight. The Fed is all but certain to cut for the third time in a row, and while Jay Powell will of course leave the door open to further cuts, there’s a sense this should be the last cut this year. The FOMC is already divided on cuts, putting pressure on the dovish core to justify why more are needed, and although there has been some softening in the economic data since the last meeting, it’s by no means all bad and the immediate market-based pressure to cut has subsided. More in our Fed preview later.

There is a risk a balanced statement is taken as hawkish by markets, given the weight of expectations. That’s a key reason why the Fed won’t surprise by not cutting – doing so will only tighten financial conditions and undo all the positive energy from cuts it’s already carried out. But it may start guiding markets to expect the current mid-cycle adjustment to finish.

However given growing market expectations for the Fed to make this its last cut if the year, markets could be met with a dovish surprise. Funnily enough a lot may depend on the Q3 advance reading ahead of the Fed statement. A sub-2% print is on the cards. Weakness in manufacturing and a slowdown in the global economy are starting to weigh on the American economy, but we think the consumer remains more resilient. 

USDJPY is near 2-month highs a little under the 200-day moving average at 109. If the market sees a hawkish cut a push above that level is on, bringing 109.50 into view. Also bear in mind the Bank of Japan, which may use the cover of other central banks easing to hoover up even more Japanese securities. It’s expected to stand pat but signal it may act if required. A surprise move to additional stimulus would further pressure JPY. However an easing in trade tensions and softer yen means the BoJ doesn’t need to panic.

Overnight data showed Japan retails sales surging in September by 9% but this was due to consumers bringing purchase forward before the sales tax hike so will only make the Q4 numbers look even worse.

The dollar backed off highs against the euro yesterday. EURUSD regained the 1.11 handle and is sitting pretty at 1.1110. Data this morning showed France’s economy grew more than expected in the third quarter, expanding 0.3% in the three months to the end of September. German inflation data is on the way all morning.

GBPUSD continues to track around the 1.2850/1.290 area and will likely remain in ranges before the election. In early trading cable pushed up to 1.29 and could yield more upside as the market works itself out. But you feel it’s going to be hard to see a break above 1.30 unless there is real momentum in the polls. And with no deal seemingly averted, the downside is limited from here. Could be treading water until Christmas.

Quick word on Brexit – well it’s on pause. No! But that’s because we get six weeks of General Election bants instead. Yes! Sterling will now become a hostage to polling data.  Polls showing a Tory majority win is net positive as it would mean leaving with Boris’s deal, while anything else is net negative as it implies new uncertainty.

Gold is making tracks south with markets eyeing the Fed to pause its rate cut cycle. Real yields are ticking higher with 10-yr TIPS up to 0.23% from 0.1% at the start of the month. The problem for gold right now is that inflation expectations are falling and the Fed looks set to stop its easing cycle for the time being and we’ve seen US Treasury yields rebound.

Equities

Standard Chartered shares rose in Hong Kong after the bank posted a quarterly profit of $1.2bn, up 16% from the year before. It’s beaten expectations amid a challenging environment and managed to keep costs flat while simultaneously growing revenues. StanChart seems to have shrugged off any ill effects from the US-China trade war and unrest in Hong Kong. Return on tangible equity climbed to 8.6% for the nine months YTD, seemingly on course to hit 10% by 2021. It’s facing growing headwinds though, so much like peers this profitability target is not a slam dunk despite the solid performance this year. 

Next produces a similar set of results each quarter – online going great guns, in-store floundering. So no surprises from today’s breakdown showing online sales up 9.7% and in-store down 6.3%. Product full price sales were net +1.6%. It’s getting something, indeed a lot, right but there comes a point when they’ll be expected to do something about the store estate to reduce costs.

Overall Q3 full price sales rose 2% including interest income, beating guidance. September’s warm weather hit sales but the cold snap in October was a boost – this bodes well for Q4 although management don’t see the same uplift for the rest of the year as they witnessed in October. Full year profit guidance maintained at £725m Importantly this means annual profit growth again at Next. It’s small at just +0.3%, but it’s a whole lot better than the May forecast of -1.1%. Shares slipped probably due to the September soft patch. All in all though Next is in good shape. We noted in July and that Next had delivered a blockbuster second quarter as sales growth picked up markedly and was well ahead of expectations. Despite the gloom it’s been raising rather than lower guidance – the FY outlook could still conservative.

Deutsche Bank – the erstwhile German powerhouse reported a loss of €823m in the third quarter and a 15% decline in revenues. The loss is in large part due to restructuring costs that are the necessary evil of trying to get the bank back to profitability. Can it get any wurst? Management are comfortable with the figures, largely because they reflect large restructuring costs that they think will not last forever and the core bank posted a pre-tax profit of €352m. Restructuring takes time, of course, and may be more expensive than analysts think, but Deutsche has had a decade and several attempts at this already. And the decline in revenues can’t be masked. Bond trading is about all it has left in investment banking and the fixed income division posted a 13% drop in revenues. Shares -3.5% in early trade.