Dollar Weak, Equity Markets Sink After FOMC

  • Global equity markets did not like what the Fed had to say yesterday
  • The market is signaling that Powell is too upbeat and risks pushing the US economy into recession
  • Bank of England is expected to keep policy unchanged; UK parliament goes into recess until January 7
  • Riksbank and BOJ both kept policy unchanged, as expected
  • PBOC will supply low-cost liquidity to banks willing to lend to smaller companies; Australia reported November jobs data
  • Indonesia and Taiwan central banks kept rates steady, as expected
  • Czech also expected to keep rates steady and Mexico expected to hike 25 bp

The dollar is broadly weaker against the majors, reversing the gains seen right after the FOMC decision.  The Scandies are outperforming, while the dollar bloc is underperforming.  EM currencies are mostly firmer.  MXN and ZAR are outperforming, while KRW and IDR are underperforming.  MSCI Asia Pacific was down 1.2%, with the Nikkei falling 2.8%.  MSCI EM is down 0.5% so far today, with the Shanghai Composite falling 0.5%.  Euro Stoxx 600 is down 1% near midday, while US equity futures are pointing to a flat open.  The US 10-year yield is up 2 bp at 2.77%.  Commodity prices are mixed, with Brent oil down 3.4%, copper down 1.9%, and gold up 1%.

Global equity markets did not like what the Fed had to say yesterday.  US stocks sold off after the FOMC, with DJIA making a new low for this year around 23163 and S&P making a new low for this year near 2489.  Weakness carried over into the Asian and European markets, though US futures suggests some stability is possible when markets open today.

What did the Fed tell us yesterday?  The FOMC hiked the Fed Funds target range to 2.25-2.50%, as expected.  We also got a dovish shift in the Dot Plots, but the overall message was clearly not as dovish as markets were expecting.  Powell said balance sheet reduction is on auto-pilot, dashing the hopes of some that were hoping for some flexibility.  Most importantly, Powell seemed to put little weight on recent equity market movements, supporting our view that there simply is no Powell Put.

What are markets telling us?  Despite Powell’s upbeat view on the economy, markets are saying that they think the Fed is making a mistake.  That is, the Fed (and by extension us too) is too upbeat on the economy and so will continue to hike and likely push the US economy into recession.  The dollar remains under pressure, which continues the break from the usual gains it sees when equity markets fall.  This bears watching.

Market expectations for the early 2019 FOMC meetings are low.  According to WIRP, the odds of a hike on January 30 are a miniscule 2.1%, while March 20 is a bit higher at 22.9%.  By signaling one fewer hike next year, its seems unreasonable to expect another hike so soon in the following quarter.  The May 1 and June 19 FOMC meetings become more interesting, especially if the US economy remains firm in Q1.

The implied yield on the January 2020 Fed Funds futures contract is currently around 2.53%, up from near 2.5% yesterday.  That was the lowest since May 30 and down sharply from a peak near 2.95% on November 8.  With effective Fed Funds likely to move to around 2.40% after yesterday’s hike, this current implied yield suggests that less than one hike is priced in for 2019.  Furthermore, the Fed Funds market is still pricing in potential rate cuts in 2020.

Bank of England is expected to keep policy unchanged.  Until Brexit has been cleared up one way or another, the BOE is simply stuck in a wait and see mode.  In the event of a no-deal Brexit, it’s hard for us to see the bank hiking rates.  Yes, there may be inflationary impulses from a plunging pound, but the recessionary impulses are likely to be even stronger.  Ahead of the BOE decision, the UK reported strong November retail sales.   Headline sales rose 1.4% m/m vs. 0.3% expected, while sales ex-auto fuel rose 1.2% m/m vs. 0.2% expected.

The UK parliament goes into recess today and returns January 7.  This further limits Prime Minister May’s time to convince MPs to support her plan.  She certainly couldn’t convince the EU to cut her some slack, as her visit to Brussels last week yielded nothing but tough talk from EU officials, who stressed that the deal “was not open to renegotiation.”  Sterling should remain heavy and we look for a test soon of this month’s low near $1.2480.

Sweden’s Riksbank hiked rates 25 bp to -0.25%.  Consensus was no change, though a handful of analysts saw a hawkish surprise.  This was the first hike in seven years.  However, the bank revised its rate path lower, suggesting that the next hike would likely be in H2 2019.  EUR/SEK is lower on the hike but still within recent ranges.  On the other hand, the NOK/SEK cross is making new lows for this move and the recent break of 1.04 sets up a test of the December 2017 low near .9950.

Bank of Japan kept policy unchanged, as expected.  Governor Kuroda said it was too early to talk about exiting stimulus, adding that it wouldn’t be a problem if yields moved into negative territory.  USD/JPY fell below 112 to trade at the lowest level since October 26.  The 111.60 level is key, as a break below that would set up a test of the August 21 low near 109.80.

People’s Bank of China announced it would supply low-cost liquidity to banks willing to lend to smaller companies.  The central bank seeks to create a targeted version of its Medium-Term Lending Facility and will accept applications from banks that meet regulatory requirements and can increase credit to smaller companies. The funds will be up to three years in maturity at a rate of 3.15%, which is lower than other existing facilities that have shorter maturities.  We see other stimulus measures coming in 2019.

Australia reported November jobs data.  While headline gain of37k jobs was better than expected, the details were not as constructive.  Full-time jobs came in at -6.4k, while part-time jobs rose 43.4k.  The unemployment rate ticked up to 5.1%.  The RBA delivered what we consider to be a dovish hold this month.  Weak domestic data coupled with weak Chinese data will likely keep the RBA in dovish mode for much of 2019.  This will take a toll on AUD, which is on its way to test the October low near .7020.   Break below that low would set up a test of the January 2016 low near .6825.

Bank Indonesia kept rates unchanged at 6.0%, as expected.  CPI rose 3.2% y/y in November, the highest since May but still below the 3.5% target.  The bank said it was intervening in the spot FX market, noting that the rupiah is moving in line with fundamentals and that the current account deficit is at a “safe” level.

Taiwan central bank kept rates unchanged at 1.375%, as expected.  It noted that policy remains moderately loose and warned that global growth was slowing.  CPI rose 0.3% y/y in November, the lowest since October 2017.  While the central bank does not have an explicit inflation target, low price pressures should allow it to remain on hold through much of next year.  November export orders were reported at -2.1% y/y vs. +0.8% expected, sounding a warning for the economy in 2019.

Czech National Bank is expected to keep rates unchanged at 1.75%.  CPI rose 2.0% y/y in November, right at the target but the lowest since April.  With the eurozone slowing, we think CNB will be more cautious about tightening too quickly.

Banco de Mexico is expected to hike rates 25 bp to 8.25%.  Mid-December CPI will be reported Friday.  CPI rose 4.72% y/y in November, the lowest since June but still well above the 2-4% target range.