- The Federal Reserve delivered the widely expected hike yesterday; Yellen made two important points that ought not to be lost
- The SNB kept policy steady and repeated its usual threat to intervene; the Norges Bank surprised many by leaving its rate path unchanged
- The Bank of England is ahead and no change is expected in the neutral bias
- Bank Indonesia and Bank of Korea both kept rates steady, as expected
- Peru central bank also expected to keep rates steady; Banco de Mexico is expected to hike rates
The dollar is broadly firmer against the majors after the FOMC decision. The Norwegian krone and sterling are outperforming, while the yen and Kiwi are underperforming. EM currencies are mostly weaker. RUB and TRY are outperforming, while ZAR and MXN are underperforming. MSCI Asia Pacific was down 2%, even with the Nikkei up 0.1%. MSCI EM is down 1.6%, with Chinese markets falling 1.1%. Euro Stoxx 600 is up 0.3% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is up 6 bp at 2.63%. Commodity prices are mixed, with Brent oil up 0.8%, copper down 0.3%, and gold down 1.1%.
The Federal Reserve delivered the widely expected hike yesterday. A year ago, it suggested four hikes in 2016 were likely appropriate. The market never accepted that, and as the year progressed many derided it. Yesterday the Federal Reserve’s projections anticipated three hikes next year instead of the two that were anticipated in September.
The distribution of the forecasts illustrates what happened. In September, 7 of the 17 members expected Fed funds would finish 2017 in the 1.25%-1.50% range or higher. Yesterday, 11 did. In September, 10 members expected that Fed funds would finish 2017 in the 1.0%-1.25% range or lower. Now 6 do.
Yellen made two important points that ought not to be lost. First, she noted that the change in the median forecast was small and was the result of a few members changing their forecasts. Second, and arguably more important, some (but not all) of the participants incorporated changes in fiscal policy. This gives meaning to the old saw about a camel being a horse made in committee. We did not anticipate a change in forecasts based on fiscal policy that is impossible to make judgments on yet.
What changed in the market’s reaction function is that the rise in US rates was an adjustment in the real rate. That is to say that it appears that inflation expectations did not change. Here we measure inflation expectations by the 10-year breakeven rate (inflation-linked bond yield vs. the conventional bond yield). For example, the 10-year US yield is up 14 bp on the week while the 10-year break-even is down three basis points this week.
There are several other developments today, though the dollar’s rally and bond sell-off appear driven by the Fed. Equity markets are more mixed, with Asia following the US lower, and Europe is mostly moving higher.
First are the central banks. The Swiss National Bank kept policy steady and repeated its usual threat to intervene. It appears that it will accept some modest franc appreciation. Norway’s Norges Bank surprised many by leaving its rate path unchanged. Many had expected that although there would be no change in policy, the central bank would lower the rate path due to the krone’s strength. However, officials seemed more concerned about financial excesses and real estate prices. The krone is the only major currency not to have fallen against the dollar today. The Bank of England is ahead. No change is expected in the neutral bias. Of note sterling and interest rates are higher than when the MPC last met.
Second are the economic reports. There are three to note. Australian reported stronger than expected labor data, even though the unemployment rate rose to 5.75 from 5.6%. The participation rate rose more (64.6% from 64.4%). The 39.1k net new jobs created were all full-time positions, and the October series was revised higher. The Australian dollar is faring second best among the majors today, off 0.2% as it dips below $0.7400. Initial support is pegged near $0.7370.
The flash eurozone PMI composite was, as expected, unchanged at 53.9. The three-month average is 53.7, which is the highest since Q4 15. It suggests Q4 growth is firm around 0.4%. The details are interesting. Manufacturing jumped to 54.9 from 53.7, but services unexpectedly fell to 53.1 from 53.8. This is clearly a function of something in Germany. France’s manufacturing and service reading were both above expectations, finishing a difficult year on a firm note.
Elsewhere, we note that the details of the TLTRO will be released. The average take-down of the first two was about 32.5 bln euros. The amount is seen as generally disappointing. The Greek government claim to use its overshoot on the primary budget surplus target to make an extra pension payment and ease the sales tax in the islands hit by the refugee crisis brought a strong rebuke from the ESM. This pressured Greek assets. Today’s reports suggested that France was breaking from the ESM to side with Greece.
The euro has fallen two cents from yesterday’s high. Last year’s low was set in late March just below $1.0460 and the lowest since 2003. There is little on the charts until we get closer to $1.0075 and then the psychologically important $1.00. A move now back above $1.0550 would likely signal a consolidative phase. The US two-year premium over German has jumped to 2.05%. Many will only see the Fed’s hand in this, but look closer, and you’ll see that the German two-year yield fell to new record lows near minus 80 bp. The adjustments to the securities lending program by the ECB and Bundesbank have not been sufficient to ease the pressure in the repo market. Year-end considerations exacerbate this pressure.
Rising US yields are lifting the greenback against the yen. It has approached JPY118.50, the highest since last February. It dipped briefly below JPY114.80 yesterday. There is little chart resistance until the JPY120 area. Europe has extended Asia’s advance. In the two weeks through last Friday, foreign investors bought about JPY680 bln of Japanese equities and JPY1.39 trillion of Japanese bonds. Much of the equities are likely on a currency-hedged basis. The bonds may be financed in the cross-currency swap market rather than in the spot market.
Bank Indonesia kept rates steady at 4.75%, as expected. CPI inflation accelerated to 3.6% y/y in November after the trough of 2.8% in August. This remains in the bottom of the 3-5% target range, but is the highest rate since April. BI last cut rates 25 bp in October but stood pat in November. Rising global uncertainties should keep the bank on hold for now.
Bank of Korea kept rates steady at 1.25%, as expected. CPI inflation was steady at 1.3% y/y in November. While still below the 2% target, it is the highest rate for the year. In light of domestic political uncertainty and heightened external risks, we think the BOK will remain on hold for the time being. Last move was a 25 bp cut in June. While the BOK noted downside risks to the economy have increased, we think rising price pressures will likely prevent it from easing near-term.
Banco de Mexico is expected to hike rates 25 bp to 5.5%. However, the market is split. Of the 25 analysts polled by Bloomberg, 17 see a 25 bp hike, 7 see a 50 bp hike, and 1 sees no hike. We see a decent chance of a 50 bp move. November CPI rose 3.32% y/y, the highest since December 2014 and above the 3% target for the second straight month. PPI ex-oil rose 7.87% y/y while headline PPI rose even more (8.4% y/y). It seems that the inflation pass-through is really starting to bite and will require Banxico tightening next year as well.
Peru central bank is expected to keep rates steady at 4.25%. CPI rose 3.3% y/y in November, and remains above the 1-3% target range. Easing won’t be seen until next year, if at all. Indeed, it will be generally hard for EM central banks to be cutting rates while the Fed is raising them, even is domestic price pressures ease.