The Federal Reserve has opened the door for rate cuts and markets are intently focused on “how soon” and “by how much”. This week, equity markets fell and widespread expectations for a 50 basis point rate cut in July were dented after St. Louis Fed President James Bullard, seen as one of the most dovish FOMC members, said a rate cut of that magnitude would be “overdone”.
But while all eyes are on the Fed, it’s important to consider how widespread the easing trend has become:
All the major central banks are now considering easing policy… On Thursday, Bank of Japan Deputy Governor Masazumi Wakatabe raised the possibility of “pre-emptive action”, reinforcing the message from last week’s BoJ meeting that the central bank would consider expanding stimulus if the economy loses momentum toward achieving the bank’s inflation target. Earlier this month, European Central Bank President Mario Draghi said “additional stimulus will be required” unless macroeconomic conditions improve, and that further rate cuts were part of the bank’s toolkit. …Other developed country central banks are also in easing mode… This month the Reserve Bank of Australia cut rates to a record-low 1.25%, and we expect two further cuts in August and November 2019. The Reserve Bank of New Zealand kept rates on hold on Wednesday, but flagged rate cuts were on the agenda, likely in August. …As are emerging market central banks. So far this year, at least seven large emerging market countries have eased policy (China, India, Indonesia, Malaysia, Philippines, Russia, Chile) compared with just one that has tightened (Czech Republic). Further easing is widely expected.
In this environment, we see several opportunities within our FX strategy. Carry trades should benefit from easier global monetary policy and we are overweight a basket of high-yielding emerging market currencies (Indonesian rupiah, Indian rupee, South African rand) against a basket of lower-yielding currencies (Australian, New Zealand, and Taiwanese dollars). We are underweight the Australian dollar versus the US dollar and the British pound. The Australian dollar is a cyclical currency, and it tends to suffer in a risk-off scenario, but the prospect of further rates cuts means it may not appreciate significantly in a risk-on scenario, making it an attractive portfolio underweight at this time. We also overweight the Norwegian krone versus the Swiss franc and the Canadian dollar, as Norway is one of the few countries where rates are rising and where we expect them to rise further.