Powell’s wording sends stock higher

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Arthur Idiatulin
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China’s confidence in the need of a fresh round of credit stimulus could strengthen, as shown by the services PMI report from local agency, Caixin. The agency’s formula for the activity index gives more weight to private companies, compared to government PMI estimates which can be biased toward government supported, and thus more stable enterprises. According to the Caixin report, services PMI fell in May from 54.5 to 52. 7 points, missing projections. The composite index that combines production and services fell from 52.7 in April to 51. 5 points in May.

The China Economic Surprise Index resumed its decline, failing to develop a positive trend in the data observed during the previous two months:

As the tariff war goes on, it erodes stability of private companies the most as they tend to be sensitive to changes in foreign demand. This is because the allocation of credit from China commercial banks is skewed towards more reliable state-owned enterprises, which decreases private firms’ ability to offset economic headwinds. The overall increase in credit defaults in the economy increases the costs for private companies to get access to liquidity, while it becomes more difficult to get a credit rating for new firms. If China decides to prop up the economy with a powerful liquidity injection (as it happened in January), this may put additional pressure on the yuan. However, it could become a positive catalyst in stock market sentiments in China as well as abroad.

Fed officials also signalled that there was “plenty of ammo” to offset the adverse impact of trade tensions. Fed Chairman, Jeremy Powell, recapped their views in the speech in Chicago, saying that the Fed “will act as appropriate to sustain the expansion”. The already classic wording “to do everything necessary” sounds both alarming (due to specific shift in focus on threats) and positive. Especially since the realization of major risks has not yet reached a level where the support of the Fed looks like it came late. Investors took Powell’s comments as the Central Bank’s willingness to cut the rate in the second quarter of this year.

Powell also spoke about the problem of permanently low inflation, which limits the ability of the regulator to smooth cycles using monetary policy. Unfortunately, Powell didn’t develop the discussion about the policy experiments that were mentioned earlier (rate pegging, etc.)

Stocks edged higher after the Powell speech with the Dow gaining 2.1%. The dollar on the other hand, fell on concerns about a potential acceleration of credit expansion and a decline of fixed-income assets.

The chance of a rate cut until July, according to fed funds rate futures, is 59%.

The most outspoken in terms of providing policy guidance to the markets was James Bullard, known for his “dovish” policy bias. He said that the Fed may soon take a positive decision on cutting borrowing costs largely due to the increased risks in global trade.

The US economy is on record in the duration of economic expansion. Including the next month, the current upturn will surpass the duration of expansion in the last decade of the last century.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

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