U.S. 2-10Y yield likely to re-steepen in response to upcoming Fed rate cuts, says Scotiabank

The United States’ 2-10Y UST yield will re-steepen with a high probability in our view, a typical and natural response to upcoming Fed rate cuts. At the initial stage, the "insurance" rate cuts should weigh on the USD versus other G-10 currencies given fading yield advantage of USD-denominated assets, according to the latest research report from Scotiabank.

Fed Chairman Jerome Powell testified before the House Financial Services Committee on Wednesday evening, signalling the first US interest rate cut at the July 30-31 FOMC meeting amid looming economic risks.

Chairman Powell told the House panel that "the bottom line for me is the uncertainties around global growth and trade continue to weigh on the outlook," although the Fed’s "baseline outlook is for economic growth to remain solid, labour markets to stay strong, and inflation to move back up over time to the Committee's 2 percent objective."

More importantly, Powell said "the straight answer to your question is no," when being asked whether the strong June NFP report released last Friday had changed the risks to the US economy.

Earlier, the US central bank released its semi-annual Monetary Policy Report on July 5, pledging to "act as appropriate to sustain the expansion, with a strong labour market and inflation near the Committee’s symmetric 2 percent objective."

According to the report, "uncertainty surrounding trade policy could be leading firms to delay investment decisions and reduce capital expenditures." Shortly after Chairman Powell concluding his testimony, the Fed released the minutes of the June 18-19 FOMC meeting, which further raised market expectations of future rate cuts, the report added.

According to the minutes, "several participants noted that a near-term cut in the target range for the federal funds rate could help cushion the effects of possible future adverse shocks to the economy and, hence, was appropriate policy from a risk-management perspective."

In addition, St. Louis Fed President James Bullard said on Wednesday that the US central bank should reduce interest rates later this month as "insurance" against below-target inflation and signs of weaker economic growth.

"The Fed’s dovish stance will revive risk appetite and prop up EM Asian currencies particularly the high-yielding INR, IDR and PHP. Meanwhile, lack of a meaningful progress in the US-China trade negotiations at the moment will prevent regional currencies from rallying too much. We maintain our short USD positions against the CNH, INR, IDR, MYR and THB, while keeping a close eye on developments in the US-China trade talks," Scotiabank further added.