|20 June, 2019

Fed's dovish stance bolsters global markets

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets. Lukman holds a BSc (hons) degree in Economics from the University of Essex, UK and an MSc in Finance from London School of Business and Finance, where he studied corporate finance, mergers & acquisitions and the role of international financial institutions.

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Dollar slides and gold hits five-year highs on expectations of a forthcoming rate cut

Image used for illustrative purpose. One hundred Dollar bills.

Image used for illustrative purpose. One hundred Dollar bills.

Gettyimages

A collective sigh of relief has roared across financial markets after the Federal Reserve confirmed market expectations of the probability that interest rates in the United States will likely be cut over the coming months.

The Fed has essentially left the gates wide open for speculation to persist that a reduction in U.S. interest rates could occur as early as July. Investors on a global level have historically enjoyed the suggestion of lower interest rates from developed central banks, and the most developed central bank of them all signalling lower interest rates is going to fuel another market rally. Equity markets will not be the only asset class to enjoy this news, with the prospects of a weaker dollar moving forward accelerating another move higher in gold.

It is emerging markets, however, who will most enjoy the news of lower interest rates. We can expect for flows to move back towards emerging markets moving forward, meaning that EM stocks and their currencies will continue to edge higher against the U.S. dollar. This rally will stretch across multiple corners including the Chinese yuan, Malaysian ringgit, South African rand and as far afield as the Mexican peso.

Emerging markets across Asia, Africa, Latin America and the Middle East will all move to applaud the news that lower interest rates in the United States will encourage capital to spread across multiple developing regions.

Persistent uncertainties around the global economic outlook and muted inflationary pressures are already presumed to have encouraged at least one voting member of the Federal Reserve to cut interest rates this month. Expectations are high that the anticipated interest rate cut from the Fed could occur as early as July, but there is the possibility that it might not occur as soon as financial markets are hoping for. 

It must also be kept in mind that a rate cut in July is contingent on the outcome of the G20 meeting between U.S. President Donald Trump and Chinese President Xi Jinping.

Trading places

If the United States and China do find a resolution to the long-standing trade tensions, this will cause a rapid shift in the economic outlook and could even mean that the Federal Reserve throws the keys to lower U.S. interest rates out of the fast-moving car.  

The bottom line is that should the G20 meeting in Japan end on a positive note, with U.S.-China relations improving and stronger U.S. economic data emerging, the Fed is unlikely to push the button on lower interest rates.

This is a potential outcome that can very well become frightening and represent a significant risk to global equity markets, when considering how confident everyone has become today that the Fed will be cutting U.S. interest rates.

Appetite towards the dollar is weakening at lightning speed on market confidence that the Federal Reserve will be cutting interest rates. This can be seen in the Dollar Index (DXY), which is trading below 97. The DXY is likely to sink towards 96.50 in the near-term as investors attack the dollar.

Weakness in the dollar will mean a coordinated round of strength for currencies across the world.

Gold is shooting to the stars, comfortably securing a fresh five-year high above $1,390 this morning thanks to a downbeat Federal Reserve.

It is widely known that gold flourishes and blooms in low interest rate environments, with a weakening dollar supporting upside gains. With geopolitical tensions, ongoing U.S.-China trade developments and concerns over slowing global growth clearly straining risk sentiment, gold is likely to remain in fashion moving forward. With regards to the technical picture, the precious metal is heavily bullish on the daily charts. The bullish momentum has the potential to send prices towards $1,400 by the end of this week.

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