Markets:

Tensions on the US money market eased, but things didn’t return to normal yet. There was a full pick-up at the NY Fed’s repo operation ($75bn), but the rise of the Effective Fed Funds Rate (2.3%) above the 2%-2.25% Fed target (for the first time ever!) range suggests that dollar liquidity remains tight. It also means that Fed Chair Powell will have a lot of explaining to do tonight as to why the transmission mechanism is faltering and what the US central bank can do to solve it. In order for next policy rate cuts to be effective, the Fed might have to introduce a standing repo facility or eventually return to asset purchases to boost reserves in the financial system.

Global FI and FX markets enjoyed a quite run-up to tonight’s FOMC decision. Core bonds gain some ground with US Treasuries outperforming German Bunds. The US yield curve shifts across 3 bps lower. The German yield curve bull flattens with yields dropping by 1.5 bps (2-yr) to 4.1 bps (30-yr). 10-yr yield spread changes vs Germany narrow up to 6 bps (Greece). Better-than-expected US housing data and ECB Vice-President Guindos’ remark that monetary policy can’t be a response to everything, didn’t influence trading. The dollar slightly gained the upper hand on FX markets with EUR/USD trading around 1.1060 and USD/JPY near 108.20. Sterling slightly underperforms as Brexit talks are going nowhere. EU Juncker said that the risk of a no-deal is palpable. EUR/GBP rises to 0.8870. Stock and oil markets hover near opening levels. We expect another 25 bps rate cut by the Fed tonight with the new dot plot pointing to one additional easing step in Q4. That should mark the end to the Fed’s “mid-cycle” adjustments. Such scenario is a negative for US Treasuries and should support the dollar. The tensions on money markets and the Fed’s response will draw more than average attention. Fed Chair Powell will probably try to dodge the QE bullets (see above), but the problem might return to the surface in coming weeks/months. If markets start contemplating the possibility of a new QE-programme, it would of course halt the US Treasury’s downleg.

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News Headlines:

UK Inflation declined more than expected in August. Headline CPI dropped to 1.7% from 2.1%,  the lowest level since December 2016. Core CPI (excluding energy, fuel, alcohol and tobacco) eased from 1.9% to 1.5%. A decline in prices of computer games and a slower rise in clothing prices compared to the same month last year were behind the move. The decline occurred despite the August decline of sterling. Input prices also declined faster than expected. UK house price rises slowed further from 1.4% Y/Y to 0.7% Y/Y. Soft inflation data might give the BoE some more room the await the outcome of Brexit and keep a rather neutral bias.

Australia’s budget surplus for the 2019/20 fiscal year will likely be bigger than expected on stronger export receipts and higher tax revenues. There is also speculation that the 2018/19 budget might have printed the first surplus since 2007/08. The final result will be published tomorrow. RBA governor Lowe recently warned on the limits for monetary policy to stimulate growth, but until now the government was reluctant to step up fiscal spending.

The parliamentary elections in Israel probably again resulted in an inconclusive, deadlocked result. Benny Gantz centrist party probably slightly preceded Netanyahu’s Likud party, but none of the two parties secured a majority of 61 seats in parliament. A new lengthy and difficult process to form a government might be on the cards.

US housing starts jumped 12.3% in in August to an adjusted annual rate of 1.364 mln, the highest level since June 2007. The July figure was also upwardly revised. Housing permits also accelerated more than expected (+7.7%, to 1 419 000 annual pace). The data suggest that the decline in mortgage rates is finally supporting the housing market, which until now was said to be hampered by supply-side bottlenecks such as shortage of land and labor.

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