US Fed rate cut viewed as a mid-cycle adjustment to policy

KUWAIT: In the GCC the picture was mostly positive with the exception of the Saudi market. The S&P GCC Composite Index edged up during the month advancing by 0.62 percent despite the strong performance of key markets such as Kuwait, Dubai and Abu Dhabi. The performance of the GCC index was dragged down by a 1.01 percent decline in the Tadawul All Share Index after a string performance in June. In the UAE, Dubai was the top GCC performer for July adding 9.77 percent, followed by Abu Dhabi with 6.79 percent mainly buoyed by strong bank earnings.
It was followed closed by Bahrain with a gain of 5.21 percent and Kuwait with 4.88 percent for the Boursa Kuwait All Share Index. In Kuwait, the Boursa Kuwait Premier Market Index continued to outperform the main market recording a gain of 5.76 percent for July bringing its total performance for the year to 28 percent, by far leading the GCC markets with Bahrain and Dubai distant seconds with 15.74 percent and 15.36 percent respectively. In the broader MENA region Egypt continues to be volatile with a loss of 5.0 percent in July following a 2.4 percent in June.
The performance of Emerging markets was generally negative with the MSCI EM and the MSCI Asia ex-Japan down 1.69 percent and 2.17 percent respectively. The declines were led by significant drops in Mexico and India as the Mexico Stock Exchange Index and the Indian Nifty 50 retreated by 5.32 percent and 5.69 percent, while the Shanghai Composite was down 1.56 percent. Turkey’s Borsa Istanbul 100 Index, on the other hand, built on its previous month’s gains and added 5.80 percent during the month of July.

Markets moved mostly sideways during the month awaiting the outcomes of the highly anticipated policy meetings of the US Federal Reserve and the ECB at the end of July and the US-China trade negotiations. The MSCI AC World Index remained practically flat adding 0.17 percent during the month, while the MSCI EM Index declined by 1.69 percent. The last week of July was the most eventful in terms of policy moves. On July 25, the ECB kept key interest rates unchanged but hinted that a rate cut could be on the horizon along with more monetary easing. The ECB president Mario Draghi said that he expects rates to remain “at their present or lower levels” at least through the first half of 2020.

Fed cuts rate
The Federal Reserve, as was widely expected, lowered its target rate by 25bps to a range of 2.0-2.25 percent which marks the first interest rate cut since the financial crisis. The immediate market reaction was largely negative as Chairman Powell hinted that this might be a one-off by saying that “We are thinking of it as a mid-cycle adjustment to policy”. He later clarified that the Fed could cut rates again soon, but the cycle of cuts wouldn’t last for long. The markets had been expecting another cut before the end of the year. Shortly after the month-end President Trump said that he would impose another 10 percent tariff on an additional $300 billion worth of Chinese imports in the middle of trade talks then China threatened to retaliate. Stock markets and oil tanked while treasury bonds rallied sending yields to 3-year lows.

The S&P 500 had traded for most of the month above the 3,000 level but broke down after the Fed decision losing 1.09 percent during the last day of July to close up 1.31 percent for the month at 2,980.38. Similarly, the Nasdaq climbed steadily to new highs in July to close the month up 2.11 percent after losing 1.19 percent on the last trading day.
US economic growth remains a potential concern in the face of global and domestic headwinds. Manufacturing activity surprised on the downside; the ISM manufacturing PMI, which was expected to grow to 52.0, dropped to 51.2 in July from 51.7 the previous month. Inflation continued to weaken as the Personal Consumption Expenditures (PCE) recorded 1.4 percent in June undershooting expectations of 1.7 percent, while the Core PCE recorded 1.6 percent versus an expected 1.7 percent. Preliminary GDP figures for Q2 showed a decline to 2.1 percent from 3.1 percent for the first quarter of 2019.

European markets mixed
In Europe, the markets picture was mixed but indices generally followed the same pattern with mostly sideways movement during the month then tanking after the escalation of trade tensions. The Stoxx Europe 600 added 0.23 percent in July after a solid performance for the previous month. The German DAX declined by 1.69 percent while the French CAC40 retreated by 0.36 percent in July after recording gains of 5.73 percent and 6.36 percent in June. European GDP declined marginally to 1.1 percent in Q2 according to preliminary estimates down from 1.2 percent in Q1 but came in better than expectations of 1.0 percent. Manufacturing activity remained weak with the Markit Manufacturing PMI declining to 46.4 in July down from 47.6. The President of the ECB acknowledged the weakness and said that “a significant degree of monetary stimulus continues to be necessary to ensure that financial conditions remain very favorable and support the euro expansion”. Draghi also said that the ECB is examining additional options to support the Eurozone economy including studying “options for the size and composition of potential new net asset purchases”. Draghi hinted to a possible rate cut at a time where the market is expecting two cuts of 10 basis points each in September and December.

In the UK, the FTSE 100 Index added 2.17 percent during July at time when the new Prime Minister seems to be taking a hard stance on the Brexit negotiations with the EU. Manufacturing activity seems to have stabilized in July after having trended downwards since the end of 2017. The July Markit Manufacturing PMI recorded 48.0, at par with the previous month and marginally better than expectations of 47.7.

NBK Capital Global Markets Commentary