Central Bank of Nigeria, Foreign exchange market, Naira vs dollas, IMF, Foreign Reserves, External reserves, CBN

The general consensual expectation of the FOMC meeting from the Fed on its monetary policy stance in its September meeting was a 25bp interest rate hike; with a very high probability of another in December. The Fed did hike rates by 25bp and further hinting a December hike.

However, that was not the only expectation – there was a keen interest on the removal of the vocabulary “accommodative” from its statement. Although, that was the case, the Fed’s Chairman, Jerome Powell further reiterated that the deletion of the vocabulary does not in any way mean that the central bank’s monetary stance isn’t still accommodative. Subsequently highlighting the hawkishness of the Federal Reserve on its forward guidance.

One take from the aforementioned is that the Fed is not focused on supporting the economy – as current fiscal stimulus is adequately bolstering corporate earnings, thus enabling compression of equity risk premium alongside higher real yields on the back of increasing optimism on economic growth and earnings outlook. This ripple effect have caused high-yielding asset to reach record highs, boosting consumer confidence. In short, the US economy is currently growing well above its potential (see chart below)

There is a high likelihood that the neutral interest rate – the supposed equilibrium rate which neither stimulates economic growth nor cools it down – have been stretched higher due to fresh economic stimulus from tax cuts and increase in public spending. Meanwhile, the Fed published dot plot highlights median dot continue to gravitate towards 4 hikes in 2019 with nominal rates ending at 3.25-3.50%, median assessment at 3.4% by 2020 – holding at this rate for a year before falling back to the long-term level of 3%. Also, median assessment of sustainable unemployment rate will fall at the 4.5% level.

Amidst this significant growth, the downside of the US economy growing above its potential is the risk of ‘overheating’. The yield curve is flattening – short-term rates is moving higher compared to the longer-term rates, thus increasing the likelihood of an inversion. Historically, the yield curve inversion has served as an effective indication of an overheated economy, with a recession subsequently following.

If this flattening rate should continue, we should expect the yield inversion of the curve to occur within next year or in the early part of 2020 – which would also be coinciding with the end of current fiscal stimulus, thus  increasing the probability of a weaker macro backdrop causing short-term neutral rate to converge with longer-term equilibrium rate into 2020, eventually halting the Fed’s hiking cycle.

For Emerging Markets (EM), the current unperturbed strength seen in the US economy have seen capital flow from EMs into US as investors “fly for quality” amidst significant geopolitical and trade tensions. Nevertheless, should the aforementioned narrative hold water we should expect significant rebound amongst EM’s financial assets in 2019 on the back of a US economy nearing overheating.

To take advantage of possible weakness in the USDollar by trading global

financial instruments, kindly visit —-> www.eagleglobalmarkets.com


This article was contributed by Eagle Global Markets (EGM).

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