Morning Commentary: A Race to the Bottom

Foreign Exchange - Morning Commentary

A Race to the Bottom

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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
Markets and central banks have reacted strongly over the past week to the heightened tensions between the U.S. and China that are now overlaid with the potential use of currencies as weapons. I have seen many articles referring to this new phase of the trade war between the U.S. and China as entering the equivalent of a Cold War. As markets brace themselves for a long and drawn out trade and currency war, the fear and likelihood of a faster global slowdown or global recession is on the rise as countries race to the bottom to lower interest rates and weaken their currencies.
Overnight, three Asian central banks shocked the markets by taking aggressive monetary policy actions to help their economies. New Zealand stunned the markets by cutting rates by 50 bps, double the expected reduction; it is the weakest G10 currency today. Thailand also surprised the markets by unexpectedly cutting rates by 25 bps, and India cut by a larger-than-expected amount of 35 bps. It is clear that central banks are taking preventive measures for what they now see as increasing odds of a sharper global slowdown.
One commentator, whom I highly respect, raised concerns that lower interest rates and QE will not necessarily remedy the problem this time. Trade flows and the global supply chains are not as sensitive to interest rates changes as other parts of the global economy. When fear grips the markets, it is not easy to change market psychology by simply lowering interest rates; if anything, lower interest rates are a warning sign of further economic distress.
Yield curve inversions, when longer term interest rates fall below short term interest rates, are often used as a warning sign of a recession.  An early metric for measuring the probability and likelihood of a recession is measuring U.S. 3-month yields against U.S. 10-year yields, and that inversion is at its deepest, for this cycle, at -40 bps. It is approaching historical inversion levels where the U.S. economy did indeed slip into recession. The odds of a Fed rate cut at the September 18 meeting are at 100% with increasing odds of a 50 bp cut. Will it change the market dynamics?
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