- Much of the commentary about the Fed’s action have noted that the FOMC statement used the word “gradual” not once but twice as evidence of its dovishness
- Although it is not final, the US Congress is set to approve large spending and revenue bills that do two big things
- It is the drop in oil prices more than the Fed hike that seems to have spurred a significant global bond market rally today
- November UK retail sales rose more than three times what the Bloomberg consensus expected, and still sterling has struggled in the face of the greenback.
- Japan’s November trade balance slipped back into a deficit
- Perhaps the biggest surprise of the day has Norges Bank’s decision not to cut interest rates.
- Argentina’s new Finance Minister Alfonso Prat-Gay announced that capital controls will be eliminated and peso will be allowed to float
- Now that the Fed has hiked, the monetary policy divergences in EM now come to the fore; Indonesia, Philippines, and Taiwan have already met, while Mexico meets later today
Price action: The dollar is mostly firmer against the majors ahead after the FOMC commenced lift-off. The Norwegian krone is the exception, up 0.5% against the USD after the Norges Bank kept rates steady. The Swiss franc and the Swedish krona are underperforming. The euro is trading lower around $1.0840, the lowest since December 8, while sterling is trading at its lowest level since December 3 near $1.4935. Dollar/yen is trading back above 122, near 122.40 currently. EM currencies are mostly softer. IDR and INR are outperforming and up slightly, while SGD, BRL, and RUB are underperforming. Indonesia and Philippine central banks met and kept rates steady, as expected, while Taiwan surprised with a 12.5 bp cut. Mexico meets later today, we see risk of no hike. MSCI Asia Pacific was up 1% on the day, with the Nikkei up 1.6%. MSCI EM is up 1%, the third straight up day after a streak of nine straight down days. The Shanghai Composite was up 1.8% while the Shenzen Composite was up 2.7%. Euro Stoxx 600 is up 2% near midday, while US futures are pointing to a lower open. The 10-year UST yield is down 6 bp at 2.24%, while European bond markets are mostly firmer. Commodity prices are mostly lower, with oil down 1% and copper down 1.5%. Grain prices are lower after Argentina cut export taxes, which will increase global supply.
Asia extended the US dollar’s post-Fed gains while Europe has seemed content to consolidate the move, perhaps waiting for US leadership.
Much of the commentary about the Fed’s action have noted that the FOMC statement used the word “gradual” not once but twice as evidence of its dovishness. The Fed’s dot plots continued to signal that the majority of officials see a 1.375% Fed funds rate at the end of 2016 as appropriate. The Fed may call this gradual, but the December 2016 Fed funds futures contract implies that the Fed funds will average 84.5 bp at the end of next year. The Fed’s gradualism is more aggressive than the market.
A key unknown is where the Fed funds market will settle relative to the range. We suspect it will average below the middle of the range. This will maximize the Fed’s control, with interest on excess reserves set at the upper end of the 25-50 bp range.
Although it is not final, the US Congress is set to approve large spending and revenue bills that do two big things. First, it extends numerous tax cuts that were set to expire. This means that the headwinds from fiscal policy will likely be reduced though it is difficult to see it as truly stimulative, as it extends the status quo. Second, and what has captured the imagination of the market, is the lifting of the ban on US oil exports. This coupled with new Iranian supply expected to hit the market shortly has weighed on crude prices (and sparked a narrowing of the WTI/Brent spread).
It is the drop in oil prices more than the Fed hike that seems to have spurred a significant global bond market rally today. European bond yields are off 5-8 bp, with the core down more than the periphery. US 10-year yield is off 6 bp to 2.24%. Although short-end yields are also lower, the premium the US pays over Germany on two-year money is widening for the fourth session.
At 134 bp, it is up 12 bp this week. It is within three bp of the multi-year high set just prior to the ECB meeting earlier this month. The euro low near $1.0830 was seen in Asia and recovered to almost $1.0880 in early Europe. We continue to see the euro largely confined to a $1.08-1.10 trading range. A break of $1.0780 would be noteworthy. On the upside, we think $1.0920 may be an important level.
November UK retail sales rose more than three times what the Bloomberg consensus expected, and still sterling has struggled in the face of the greenback. UK retail sales (excluding gasoline) rose 1.7%. The consensus was for a 0.5% increase. The October swoon was revised to -0.8% from -0.9%. Discounts related to “Black Friday” helped pump up sales. The market did not see the report as bringing forward a BOE rate hike. The June 2016 short-sterling futures contract was a bit firmer, implying a slightly lower yield.
Sterling’s session low was recorded in Europe near $1.4920. It initially responded well to the headline news but ran into sellers as it poked through $1.50. This area is likely to cap upticks. The month’s low a little below $1.49 beckons. The year’s low set was recorded in April (~$1.4565).
Japan’s November trade balance slipped back into a deficit. Although that was not surprising, how it got there was. Exports fell twice the pace the market expected, contracting 3.3% year-over-year. This is the second consecutive month of year-over-year declines, and the December and January reports are also likely to be challenging due to base effects. This is the weakest report since the end of 2012.
Imports also fell more than expected, but less than in October. Imports in November fell 10.2% year-over-year. The consensus was for a 7.3% decline after the 13.4% fall in October. Given the past decline of the yen (more a 2014 story than 2015), the export performance has surprised many observers. The dollar’s gains were extended to almost JPY122.65 in Asia and drifted lower in Europe. Lower US Treasury yields, which would act as a drag, have been neutralized by the rally in stocks. The JPY122.40 area corresponds with a 61.8% retracement of the post-ECB drop. A break now of JPY122.00 would suggest a new consolidative phase.
Perhaps the biggest surprise of the day has Norges Bank’s decision not to cut interest rates. The krone rallied nearly 1.5% against the euro in response. The deposit rate has sat at 75 bp since September. It finished 2014 at 1.25%. Governor Olsen sounded cautious, but the door to rates cuts next year remains wide open. The central bank sees the deposit rate as low as 39 bp in Q4 16. Olsen signaled a rate cut in March was “probable.”
Following the ECB meeting, the euro rallied from NOK9.09 to NOK9.60. It has been capped there. Today it was sold to almost NOK9.41, which corresponds to a retracement objective. A break would signal a further correction toward NOK9.35.
As expected, Argentina’s new Finance Minister Alfonso Prat-Gay announced at a press conference that capital controls will be eliminated and peso will be allowed to float. Since this announced after markets had closed, we have yet to see how markets will react. We would expect a floating peso to trade somewhat weaker than where the so-called “Blue Chip” parallel rate was trading. Officials said that FX intervention would be carried out as needed to prevent a disorderly move.
Now that the Fed has hiked, the monetary policy divergences in EM now come to the fore. To wit:
Philippine central bank met and kept rates steady at 4.0%, as expected. It raised its 2016 and 2017 inflation forecasts slightly, and El Nino poses some upside risks to inflation. Inflation risks are balance, but the central bank will likely remain cautious. Bank Indonesia kept rates steady at 7.5%, as expected. It noted that room for easing remains open, and we think more measures (rate cuts and macro-prudential policies) will be seen in 2016. Inflation at 4.9% y/y in November has finally returned to the 3-5% target range. Taiwan’s central bank cut rates 12.5 bp to 1.625%. The market was split, however. Of the 25 analysts polled by Bloomberg, 13 saw no change, 11 saw a 12.5 bp cut to 1.625%, and 1 saw a 25 bp cut to 1.5%. The economy remains soft, while CPI rose only 0.5% y/y in November. As such, we see further easing ahead.
Banco de Mexico meets and is expected to hike rates 25 bp to 3.25%. Of the 26 analysts polled by Bloomberg, 5 see no change and 21 see a 25 bp hike to 3.25%. The recent weakness of the peso and official comments have fanned expectations that on the day after the Fed hiked rates, Mexico will do the same. Given that the peso’s weakness has not spilled over to boost prices, the urgency to follow suit is not immediately evident. However, we believe the central bank may be extra cautious and hike rates now in order to anchor inflation expectations. It’s a very close call but with the peso holding up fairly well, we think there is a decent chance of a dovish surprise (no hike).