The Federal Reserve made no changes at its latest meeting, keeping its fed funds interest rate at 0.00-0.25% and its pace of quantitative easing at USD120 billion of bond purchases a month.
Source: Bank of Singapore, Bloomberg
The Fed was unlikely to make any changes given uncertainty over the US elections and second virus waves. Chairman Powell noted: ‘the outlook for the economy is extraordinarily uncertain and will depend in large part on the success of efforts to keep the virus in check.’ Powell did, however, signal that bond buying could be raised at the Fed’s next meeting in December if the economy needs further support - a move that is a likely reaction to the outcome of the elections.
Washington seems set for a period of gridlock - a Democrat White House facing a Republican Senate – that will have four likely consequences.
Source: Bank of Singapore, Bloomberg
First, the Fed may need to ease more to support the US recovery as a divided Congress will be unlikely to approve further large-scale fiscal stimulus. Thus, the fed funds rate may not be raised before 2024 or 2025 and the central bank could increase its pace of quantitative easing from as early as next month as Powell signalled.
Second, more limited fiscal support worth around USD0.5 trillion or more is still likely to be passed by Congress in early 2021. But in the absence of another major package - like the USD3.0 trillion of aid approved at the height of the pandemic in the spring - US Treasury yields will stay at historically low levels as the chart opposite shows. We thus keep our forecast for 10Y yields to rise modestly to 0.90% over the next year.
Third, very loose monetary policy and less expansive fiscal policy will undermine the USD. The currency is also likely to weaken as a Democrat White House would be less aggressive on trade, reversing the upward pressure the USD has benefited from over the last couple of years from US tariffs. The EUR has been rising since the summer as the above chart shows and we forecast the USD to fall to 1.25 over the next year.
Last, US political risks are now easing after the elections while gridlock will make it harder to reverse corporate tax cuts and deregulation.
Thus, we see the long-term outlook still favouring risk assets, supported by economic recovery, upcoming vaccines, a dovish Fed, very low yields, a weaker USD and easing US political risks.Disclaimer applicable to recommendation
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Version: July 2020