Fed holds but points to September cut

The US Federal Reserve kept the Fed funds rate unchanged at its FOMC rate-setting meeting yesterday, with the upper bound remaining at 5.50%. This had been the market consensus expectation and our own, and our view has been since April that the first cut from the Fed in this cycle will come at the next meeting, scheduled for September. This looks increasingly likely to play out when looking at the language from the FOMC communiqué and chair Jerome Powell’s press conference following the decision, with Powell stating that ‘a reduction in our policy rate could be on the table as soon as the next meeting in September.’ Our forecast remains that we will see two 25bps cuts before the end of the year, one in September and one in December, despite the dot plot of FOMC member projections having come down to just one cut in the latest summary of economic projections in June. A September cut is fully priced in by markets.

Saudi Arabia recorded a 0.4% y/y contraction in the second quarter, compared with a 1.7% y/y contraction in Q1. This marked the fourth y/y decline in a row, but it was the shallowest. As in the previous periods, the decline was driven by the oil sector which logged a contraction of 8.5% y/y in Q2 with OPEC+ and voluntary additional oil production curbs weighing on output. Non-oil activity expanded 4.4% y/y, up from 3.4% in Q1, while government activity was up 3.6% y/y in the second quarter. On a quarterly basis, headline growth was a positive 1.4%. We forecast headline growth of 1.0% in KSA this year, with oil GDP set to end the year down 4.0% as the y/y drag of lower oil production dissipates through H2. We project that lower oil GDP will be offset by 4.0% growth in non-oil GDP and a 2.0% expansion in government services.

UAE petrol prices for the month of July were announced yesterday, with prices at the pump set to rise by some 2% for August after two consecutive months of declines in June and July. The hike in prices reflects the trend in global oil prices in June, but with prices having trended lower through July, prices at the pump will likely decline again in September. Transport accounts for around 10% of Dubai’s inflation basket, with petrol prices accounting for a sizeable proportion of that, so changes in the cost of filling up tanks has implications for headline CPI inflation. Dubai’s annual inflation rate was at 3.9% y/y in June, in line with the average pace over the first half of the year.

Preliminary inflation data for July put Eurozone price growth at 2.6% y/y, up from 2.5% in June and missing expectations that it would remain at that level. Core inflation was 2.9% y/y, unchanged from June’s print and higher than the predicted 2.8%. Prices were flat at 0.0% m/m, compared with predictions of deflation of 0.1%. The upside surprise was driven by sticky services inflation at 4.0% y/y, with Germany and Italy among the member states that came in hotter than expected. The next ECB meeting is in September, with more inflation data set to be released in the meantime, but the CPI and GDP data of the past several days will likely complicate the decision-making process.

Key Economic Data and events

15:00 UK Bank of England bank rate decision. Forecast: 5.00%

16:30 US initial jobless claims, week ending July 27. Forecast: 236,000

Fixed Income

• US treasuries rallied sharply after the dovish messaging from Jerome Powell and the Fed yesterday. Yields on the 2yr fell 10bps to 4.2575%, while the 10yr yield ended 11bps lower at 4.0296%.
• Markets are pricing in 100% chance of a cut at the September meeting, with nearly 75bps of total cuts predicted before year-end.
• The Bank of England’s MPC is making its rate decision this afternoon, with market consensus that it will cut by 25bps to 5.00%. Gilts rallied yesterday, with yields on the 2yr dropping 5bps to 3.826%, while the 10yr fell 7bps to 3.970%.

FX

• The dollar lost ground yesterday as yen rebounded and the Fed struck a dovish tone. The DXY index dropped 0.4% against its basket of peers.
• The Japanese yen gained 1.8% against the dollar yesterday to close at 150.0, the strongest level since March and back from a recent 38-year low after the Bank of Japan hiked its benchmark target rate to 0.25% yesterday.
• EUR closed 0.1% higher at 1.0826, while GBP added 0.2% to 1.2856. Among the commodity currencies, NZD was the biggest mover, adding 0.8% against the greenback.

Equities

• Asian equity markets saw strong gains yesterday. The Shanghai Composite ended the day 2.1% higher, while the Hang Seng added 2.0%. In Japan, both the Nikkei and the Topix closed up 1.5% even as the yen gained after the BoJ’s rate hike yesterday but today Japanese stock indices are already down by more than 3.0%.
• In the US, the dovish messaging from the Fed saw strong gains for all three major indices, with the Dow Jones, the S&P 500, and the NASDAQ adding 0.2%, 1.6%, and 2.6% respectively.
• Locally, the DFM closed down 0.4% and the ADX dropped 0.6%, while in Saudi Arabia the Tadawul ended the day 0.6% higher.

Commodities

• Oil prices registered strong gains yesterday following three days of selling pressure, bolstered by geopolitical developments in the Middle East, and a drawdown in crude stockpiles in the US.
• Brent futures rose 2.7%% to USD 80.7/b, while WTI gained 4.3% to USD 77.9/b, and both benchmarks are up a further 0.6% in early trading this morning.