We continue to have an eye on the S&P 500, with price holding above 3000, for now, and failing to react too negatively to a strong US retail sales report, which easily beat expectations. Notably, here, the retail ‘control group’ element (the goods that feed directly into the GDP calculation), increased 0.7% vs expectations of 0.3%, resulting in a small net change higher in US Treasuries and buying of the USD.

But, what if the Fed cut by 50bp?

However, the retail numbers didn’t resonate in the rates market moving to any extent, and this has supported risk. In fact, despite the recent data, we still see a 25% chance of a 50bp cut priced on 31 July. Indeed, gold bulls will be hoping for a 50bp cut, as the market is craving a resolution and certainty to resolve one of the key battlegrounds seen in any chart on my radar. This pattern needs to resolve itself, and a 50bp cut sends the yellow metal on its merry way towards $1500.

Of course, ‘real’ (or inflation-adjusted) Treasury yields are critical to gold as well, and the combination of higher inflation expectations, should it come with a 50bp cut, would slam ‘real’ Treasury yields and that would be huge for gold. That’s a big ‘if’ of course, but if the Fed is targeting a red-hot economy and escape velocity, overlooking the recent payrolls, CPI and retail sales reports and subsequently cutting by 50bp and announcing a formal end to its balance sheet normalisation program (QT). Then, it’s not just gold that would benefit, but we would see a steeper yield curve, and US equities rally to new highs, led by financials.

– Yellow line – gold
– White – US 5yr ‘real’ Treasury yields

Bring out the big guns

In fact, in this vein, we would see the USD weaken and capital making its way into Asian equities, bonds and currencies. And it feels as if they are going to go, they may as well make an impact.

The higher probability, though, as seen in the current pricing structures is, we see a 25bp cut, with a bias to ease again – should conditions warrant. In this more probable scenario, there may be some disappointment, but in theory, we shouldn’t see too great a sell-off in Treasury’s and equity volatility shouldn’t lift too much. The fact that market-based inflation reads, like the US 5-year inflation swaps, have risen 23bp from 19 June to currently sit at 2.14%, have given us less belief the Fed is going to bring out the big guns.

External risks still the greater concern

It’s the external vulnerabilities that keep the idea of a 50bp cut going, and global trade is at the epi-centre of this concern, and the impact it is having on the corporate landscape and business investment. The fact Trump has detailed that he could raise tariffs on China at any time seems strategically crafted to keep the pressure on the Chinese. But it was a message to the Federal Reserve, that looser policy is needed.

Brexit firmly back on the radar

I certainly thought it interesting that Fed members are talking about Brexit as an external negative factor, and while there are worrying data points in the UK, when you look at the European economy and the woeful numbers seen in the German ZEW survey yesterday, and the impact a no-deal Brexit would have on both the UK and European economies, perhaps a no-deal Brexit could be a more significant issue for the global economy than most believe.

Indeed, the way things are shaping up with regards to Brexit, a general election is looking more and more likely, although the playbook to get there is still so varied, that it is hard to see how developments don’t turn ugly. GBPUSD has been the big mover through European trade, trading to the lowest levels since April 2017, and with-it flow has ramped up, with the GBP crosses getting a real working over too. We’ve seen more calm conditions through Asia, although there have been limited moves across the full G10 FX spectrum, while equity and bond markets have seen limited moves as well.

That said, it certainly feels as though GBP implied volatility picks up from here, and when it does, we adjust risk and position size accordingly. For now, though, GBP is the momentum vehicle of choice for FX hedge funds and is trending well, although the rules-based funds would already be holding max-long exposures.

With the UK recording decade-high wage growth, the fact there has been no support here for the pound shows this is an out-and-out political currency and data is often irrelevant. Consider that we get UK CPI at 18:30 aest, and with the consensus expecting 2% YoY growth (headline), one questions if a hot number just offers more compelling levels for traders to get short and ride the trend. One to watch.

Aside from the event risk mentioned above, we get US housing starts and building permits, crude inventories and earnings from Bank of America.

Published by Chris Weston, Head of Research, Pepperstone