Greenback Softens Ahead of FOMC

Federal Reserve Building

  • A Fed hike today is as nearly a foregone conclusion as these things can get; investors will quickly look past a 25 bp hike.
  • Looking ahead after today’s Dutch elections, many investors have been more worried about next month’s French presidential election
  • Sterling retreated today after today’s labor report
  • The suspension of the US debt ceiling in October 2015 expires today
  • Czech Republic reported January retail sales, construction and industrial output; Hungary central bank releases its minutes

The dollar is mostly softer against the majors ahead of the FOMC decision. Sterling and the Antipodeans are outperforming, while the Scandies and the yen are underperforming. EM currencies are broadly firmer. KRW and ZAR are outperforming, while MYR and CNY are underperforming. MSCI Asia Pacific was flat, with the Nikkei falling 0.2%. MSCI EM is up 0.1%, with China shares rising 0.2%. Euro Stoxx 600 is up 0.2% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is down 2 bp at 2.58%. Commodity prices are mostly higher, with WTI oil up 1.8%, copper up 0.3%, and gold up 0.2%.

The US dollar is paring yesterday’s gains as the market awaits the outcome of the well-telegraphed FOMC meeting. In recent weeks, the combination of data and official comments has swayed markets, which had previously anticipated a hike in May or June.

A hike today is as nearly a foregone conclusion as these things can get. The idea of not wanting to surprise the market, which some Fed officials underscored, can work both ways. It means market expectations are primed. It also means that when there is a nearly 100% chance discounted, not to deliver would also be a destabilizing surprise.

Investors will quickly look past a 25 bp hike. Indeed, the market will be looking for clues on the timing of the next one. There are two elements here. One is the dot plot. We expect the median and average to creep up, and suspect many may be underestimating the hawkishness of the regional presidents. The other element is the assessment of the balance of risks.   Despite the prospect of slower Q1 growth (which is also consistent with the pattern since the financial crisis), the risks may be tilted higher going forward.

A Wall Street Journal survey found almost 70% of responding economists expect the next hike in June and 8.5% say July. A fifth expected the Fed to wait until September. Based on the current information set, we are inclined toward June. It is partly based on the understanding that gradual hikes rule out back-to-back meeting moves now. Our view is also informed by indications that the Fed’s leadership has grown more confident of the resilience of the US economy and is no longer looking for confirmation.

Instead, we think the Fed has shifted to looking for opportunities to normalize policy. Also, expectations assume that European politics will not be significantly disruptive to the markets (meaning no populist-nationalist victories).

Today’s Dutch election is the first test of this last point. Recent polls suggest the populist-nationalist PVV has waned in recent weeks. The Dutch themselves and, by and large, the investment community has never been particularly worried about the outcome. It is recognized that Wilders does express a current among the Dutch electorate, but it is not growing. The fragmented and decentralized nature of Dutch politics puts a premium on coalition building which serves to temper extreme views.

Many investors have been more worried about next month’s French presidential election. In a turn of events, all three leading candidates have legal problems. Le Pen and Fillon’s legal issues have been around for weeks, while Macron’s problems came to light yesterday, involving a contract awarded without an open bidding process when he was the Economic Minister.

Meanwhile, sterling has recovered from yesterday’s spike to almost $1.21. Royal assent for Brexit is expected tomorrow, and that will leave triggering Article 50 in Prime Minister May’s hands. What kind of UK will leave? This was a factor that weighed on sterling yesterday. Scotland wants another crack at independence, and Northern Ireland voted to remain, and the unification of Ireland has been broached with Sinn Fein seeking a referendum as soon as practical. Leaving aside the polls conducted by Scottish companies, the others, like YouGov/Times show that outcome of a referendum has not changed much. Spain has made it clear that it would not allow Scotland to join the EU. It wants to give its own independent-minded regions no incentives. Hence, Sturgeon’s interest in the EFTA instead.

May has signaled that she will not attend the EU summit to celebrate the 60th anniversary of the Treaty of Rome on March 25. Instead, within a day or two of it (March 27?) she is expected to formally trigger Article 50. Once that takes place, the UK’s initiative is lost and it passes to the EU, including on when to begin the negotiations. Some press reports suggested formal talks might not begin until June.

Sterling retreated today after today’s labor report. Data showed a steeper slowing of wage growth than had been anticipated, even though the claimant count fell (-11.3k in February after a 41.4k decline in January). The unemployment rate slipped to 4.7% (in three months through January), which is the lowest since 1975. Average weekly earnings (three months, year-over-year through January) slowed to 2.2% from 2.6%. The Bloomberg median forecast was for 2.4% increase. It is the weakest wage growth since last April.

The shadow MPC at the UK Times seems out of step. Three favor a hike tomorrow, and another three think the next meeting. A Reuters poll results don’t see a hike until 2019. Look for a unanimous decision tomorrow from the BOE’s MPC to keep rates steady. The BOJ and SNB also meet tomorrow and are expected to keep policy on steady.

The suspension of the US debt ceiling in October 2015 expires today. It is already having an impact on the T-bill market, where yields are elevated. In the past, fiscal concessions are sought in exchange for lifting the cap. It is not clear how this will play out this time. There are numerous measures the Treasury Department can and will take to avoid disruptions. This can extend for several months. Meanwhile, the spending authorization may be more pressing as it reaches its limit next month. Also, as early as tomorrow, President Trump is expected to unveil the first outlook for the FY18 budget.

Lastly, the other development worth highlighting here is the strong rally in iron ore and steel. In China, iron ore prices rose 5.2% today after 4.3% yesterday. Steel reinforcement bar rose 1.3% to the highest in nearly four years. It has risen 27% this year already. Recent Chinese data showed that steel output rose 6% in the January-February period year-over-year. Oil prices are also recovering today after the April light sweet futures contract approached $47 a barrel yesterday. API reported an unexpected drawdown. The EIA data will be reported in the US morning.

The North American session also features US CPI (core expected 2.2% from 2.3% in January) and US retail sales. The risk seems to be on the downside after the 0.4% rise in February at the headline and core (GDP components). The Empire State manufacturing survey for March (one of first March readings) may soften from 18.7 in February.

Czech Republic reported January retail sales, construction and industrial output. Retail sales rose 7.7% y/y vs. 7.5% expected, while industrial output rose 9.6% y/y vs. 7.9% expected. Rising inflation and a robust economy should keep the CNB on track to exit the koruna floor before mid-year. The next policy meeting March 30 is too soon for an exit, but either the May 4 or June 29 meeting should be seen as “live.”

Hungary central bank releases its minutes. At the February meeting, it kept policy steady. Inflation was 2.9% y/y in February, the highest since January 2013. The minutes will be studied to see if the central bank is concerned enough to stop easing policy via unconventional measures. The central bank is due to review its cap on commercial bank deposits for end-Q2 (cap at HUF750 bln for end-Q1) at its next policy meeting March 28.