Powell adds to lower yields momentum

USD: Fed could cut rates “sooner rather than later”

The 2-year UST bond yield has declined further today after dropping yesterday in part on the sharp drop in crude oil prices and also due to comments made by Fed Chair Powell in Q&A after his testimony to the House Financial Services Committee. Crude oil prices have bounced a little today after a 15% drop in the previous three trading days. Trump’s comment that “China can continue to purchase oil from Iran” added to ceasefire related selling on the belief the comment could open up more Iranian oil being supplied onto the global markets – a market the IEA just last week stated in its monthly report was “well supplied”.

But the fact that Treasury yields remain under downward pressure today likely highlights the impact Powell’s comments could have going forward. Powell’s comment that the Fed could cut rates “sooner rather than later” if inflation remains contained added to comments from previous FOMC members that confirms a shift is taking place toward cutting rates. Of course, it is important to give context here – Powell did also express clearly the belief that inflation is set to pick up due to the likelihood that Trump’s tariff actions will feed through into higher inflation. This will especially be the case if Trump follows through with his reciprocal tariff plans in full and implements much higher rates from 9^th July onwards.

But the extent of the pick-up in inflation is likely being debated more given the comments from Chicago Fed President Goolsbee this week who stated that the burden of paying the tariffs could be shared more evenly across producers, suppliers and consumers. If so, then the impact on CPI will be less than expected. Given Governor Waller and Bowman explicitly mentioned July as a possibility for a rate cut means there could be other FOMC members shifting their views on inflation. A July rate cut would certainly increase the prospect of three rate cuts, and not two as is currently signalled by the median dot in the Summary of Economic Projections.

The NFP report next Thursday is very important. A weaker print will certainly see increased speculation on a July rate cut, with pricing currently only showing a slightly less than 20% chance of a cut by then. But September is now fully priced which certainly makes sense. If crude oil falls further from here, it will help counter tariff risks and there also remains a reasonable chance of some Trump back-tracking on tariffs which would also increase July rate cut risks. This backdrop will likely keep the dollar under downward pressure. The DXY index yesterday closed at the its lowest level since March 2022 when the worst phase of the global inflation shock was just getting going.

DXY CLOSES AT LOWEST LEVEL SINCE MARCH 2022

Source: Bloomberg, Macrobond & MUFG GMR

GBP: BoE speakers indicate a clear bias & QT cut could be coming

Yesterday was a busy day for central bank speakers not just because of the Fed but also with the BoE – there were six separate MPC speaking events. Governor Bailey spoke twice along with Deputy Governors Ramsden and Breeden, Chief Economist Pill and MPC member Greene. We know already from the policy decision vote earlier this month that Deputy Governor Ramsden believes the economy already justifies further monetary easing so the focus was on the other speakers to gauge a possible shift in guidance or pace of easing going forward. One takeaway from the comments yesterday is that the MPC is likely honing in on the labour market more and more and see that as the key downside risk that could trigger more cuts than expected. Megan Greene cited labour market loosening in her comments as justification for concluding there are downside risks to growth. However, Greene also saw upside risks to inflation although she did acknowledge there was some “nascent” evidence of trade diversion from China that would be disinflationary. All in though no sense of Greene being in a camp that could argue for a faster pace of easing. Ramsden was clear it is the labour market that is the primary reason he sees scope for further easing with the labour market providing a “sufficiently strong” case for cutting rates again. Breeden and Pill didn’t make specific monetary policy comments but Governor Bailey dropped a hint of a potential change to QT policy, which will be confirmed either way at the policy meeting in September.

Bailey stated that the QT decision will be “more interesting” this year and will soon conduct its review in order to make the announcement in September. Importantly, Bailey stated that the BoE assessment would take into account any sell-offs in the Gilt market. The upward pressure on long-term rates had resulted in “quite a steepening” of the yield curve, although he was quick to say that that was a global development and therefore not linked to QT. Of course the BoJ would make the same argument about the steepening of the JGB curve but it still last week announced a 50% cut to the pace of its QT plans. The BoE in its assessment could also conclude that the upturn in usage of liquidity via the weekly term repo facility had risen to a level that could allow for some alleviation of liquidity drainage via QT – the weekly term repo allotment hit a record GBP 70bn last week.

A slowing in the pace of QT (GBP 100bn per year at present) would certainly help sentiment in longer-term debt that has been an issue in the UK, the US and more recently Japan. The hints from Governor Bailey will certainly lift expectations further that the pace of QT will be cut which all-else-equal is a positive for Gilts. Rolling correlation analysis (chart above) indicates a negative correlation between 30-yr Gilt yields and GBP has been a feature since the Liz Truss episode in 2022 and hence assuming that was to persist, could be viewed as a supportive factor for the pound.

ROLLING CORRELATION BETWEEN 30YR GILT YIELD & GBP

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com