FOMC Minutes Rattle Markets

  • FOMC minutes are usually a ho-hum affair, but not this time
  • US rates reacted accordingly, as did the dollar initially
  • The US Treasury released its semiannual FX report to Congress yesterday afternoon
  • Commissioner Oettinger said that the EU is likely to reject Italy’s draft budget plan
  • UK reported soft September retail sales; EU has reportedly called off the November Brexit summit
  • Bank of Korea kept rates steady at 1.5%; Banco de Mexico releases its minutes; Chile central bank meets

The dollar is mostly weaker against the majors despite the hawkish FOMC minutes.  The Antipodeans are outperforming, while Nokkie and Loonie are underperforming.  EM currencies are mostly weaker.  TRY and HUF are outperforming, while KRW and TWD are underperforming.  MSCI Asia Pacific was down 0.6%, with the Nikkei falling 0.8%.  MSCI EM is down 0.6% so far today, with the Shanghai Composite falling 3%.  Euro Stoxx 600 is up 0.4% near midday, while US futures are pointing to a lower open.  The US 10-year yield is up 1 bp at 3.21%, the highest since October 10.  Commodity prices are mostly lower, with Brent oil down 0.9%, copper down 1.3%, and gold flat.

FOMC minutes are usually a ho-hum affair, but not this time.  The key takeaway is that several Fed officials are openly discussing a move to a restrictive policy.  As our recent piece discussed (Powell and Brainard Suggest Markets Underestimating Fed Hikes), the Fed believes that the short-term neutral rate has moved above the long-term neutral rate of 3%, which to us suggests 3.5%.  That in turn suggests that a restrictive rate would be in the neighborhood of 4%.  A lot can happen (a US slowdown) before the Fed can ever reach that restrictive rate.  However, minutes underscore the fact that the markets are vastly underestimating the Fed’s capacity to tighten.

US rates reacted accordingly, as did the dollar initially.  The dollar posted early gains against the majors overnight but has since given back the bulk of those gains.  We have been bemoaning the lack of upside movement in US yields, and this Fed news could signal the start of the next leg higher.  The 10-year yield is trading at 3.21%, the highest since October 10, but 3.25% still represents a formidable barrier.  Implied yields at the long end of the Fed Funds futures strip have backed up recently and are starting to price in a third hike in 2019.  At some point, we think markets will start thinking about a fourth hike next year.

During the North American session, the US reports October Philly Fed survey and weekly jobless claims.  The Fed’s Bullard and Quarles speak, and we suspect they will be quizzed about the FOMC minutes if there are any Q&A sessions.

The US Treasury released its semiannual FX report to Congress yesterday afternoon.  As reports had suggested, Treasury decided not to label China (or any other country) a currency manipulator.  This was the right call, and we are heartened by the fact that the US decided not to inflame tensions with China eve further.  Still, Secretary Mnuchin expressed concern about recent yuan weakness as well as the lack of transparency with regards to FX policy.  The planned Trump-Xi meeting next month will be key in thawing relations further, but it will be a long, hard slog ahead.

The yuan traded at its weakest level for this move today near 6.9450.  This simply reflects broad EM FX weakness today.  The December 2016 high for USD/CNY near 6.9650 lies near.  Many are focusing on the 7 level but there is nothing magical about it.  If EM FX continues to weaken as we expect, the yuan will get dragged along for the ride and USD/CNY will likely break above 7.

Commissioner Oettinger said that the EU is likely to reject Italy’s draft budget plan.  While he said it was his personal opinion, Oettinger surely speaks for many others on the Commission.  EU budget chief Moscovici will be in Rome today to meet with Italian Finance Minister Tria, who said that he expects “continued dialogue” with the European Commission.  The euro has recouped some of its earlier losses but the break below the $1.15 area today sets up a test of the October low near $1.1430.

The UK reported soft September retail sales.  Both headline and e-auto fuel fell -0.8% m/m, double the expected -0.4%. However, August sales were revised up a tick or two.  This comes after softer than expected CPI and mixed labor market data earlier this week.  Sterling traded at its lowest level since October 9 today near $1.3075 but has recovered some of its earlier losses.  It remains heavy and a break of the $1.3050 area would set up a test of the October low near $1.2920.

The EU has reportedly called off the November Brexit summit due to lack of progress.  The EU is now aiming for the planned December summit to complete the deal.  Prime Minister May presented nothing new at the EU dinner last night, with press reports suggesting that she is offering an extended transition period as a possible compromise.  Of course, this will not make the hard Brexiteers in her party and cabinet very happy.

Japan reported September trade data.  Exports contracted -1.2% y/y while imports rose 7% y/y, both weaker than expected.  The adjusted trade deficit was -JPY239 bln vs. -JPY333 bln expected.  Support on the downside for USD/JPY held this week, but the pair needs to break above the 113.45 area to signal a bigger bounce and to set up a test of the October high near 114.55.

Australia reported jobs data for September overnight.  While the change in headline employment was a smaller than expected 5.6k, the details were stronger.  Full-time jobs rose 20.3k and were offset by a -14.7k drop in part-time jobs.  The unemployment rate fell to 5.0% from 5.3% in August.  Still, we see no policy implications as the RBA remains stuck in dovish mode.  AUD has recouped most of yesterday’s losses but still needs to break above the .7200 area to set up a bigger bounce.

Bank of Korea kept rates steady at 1.5%.  The market was split between no hike and a 25 bp hike to 1.75%.  So was the BOK, as two dissents were in favor of an immediate hike.  CPI rose 1.9% y/y in September, the highest since and just below the 2% target.  Yet downside risks to the economy remain in place and so we think the bank was right to be cautious and stand pat.  Next meeting is on November 30.  What happens then will depend in large part on external factors.

Banco de Mexico releases its minutes.  It delivered a hawkish hold at that meeting, with one voting for an immediate hike.  Inflation has been accelerating in recent months to hit 5% y/y in September, above the 2-4% target range.  If this continues, we expect the bank to tilt even more hawkish, though a hike is unlikely unless the peso weakens significantly.  Next policy meeting is November 15.  As in the case of the BOK, what happens then will depend in large part on external factors.

Chile central bank meets.  The market is evenly split between no hike and a 25 bp hike to 2.75%. The economy is gaining strength even as inflation picks up.  At 3.1% y/y in September, it is above the 3% target and so the bank has signaled it will start the tightening cycle in Q4.  We think this week is too soon and lean towards a hike at the December 4 meeting instead.