Category Archives: US

Politics suspected of interfering with economics and markets

In the US, political intrigue, seemingly lifted straight out of a John Le Carré novel, has reached a crescendo and there are now multiple investigations running concurrently.

If we assume these investigations will run over weeks/months, the question is whether and to what extent this political backdrop is likely to impact financial markets, US government policy-making, the US and global economy and Federal Reserve monetary policy.

US equities have corrected lower, volatility has spiked and markets are seemingly ignoring positive data surprises

It has all been rather orderly so far but it is difficult to see how at this juncture, with major policy initiatives likely kicked down the road, US equities can launch another meaningful rally. If anything big data misses are likely to further pressure stocks. 

The Dollar’s performance has been mixed in the past month, posting its biggest loss against the euro in line with the fundamentally bullish euro view I expressed in December and April.

Capital inflows into the eurozone allied to a 2% of GDP current account surplus, a pick-up in economic activity and receding political risks following the French presidential elections are likely to extend the euro’s current rally near-term.

However, the ECB’s stance on its quantitative easing program will be key in shaping the euro’s medium-term path.

US economic indicators paint a blurry picture while solid global GDP growth is seemingly struggling to make further gains.

The Fed and US rates market have the unenviable task of making sense of these macro trends and a quickly changing political landscape.

The apolitical Fed will of course stay above the political fray, even if markets do not with pricing for the probability of a 25bp hike at the 14th June policy meeting continuing to oscillate between 60% and 75%.

My core scenario is that the Fed will hike rates only once more in 2017 although I acknowledge that this is not a high conviction call. The market seems still on the fence, pricing in a further 32bp of hikes in the remainder of the year.
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US Federal Reserve back in the limelight

The whirlwind of Trump policies has taken the spotlight off the Federal Reserve’s path for monetary policy since its 14th December meeting at which it hiked rates 25bp.

Mixed US macro data and acute policy and economic uncertainty have likely cemented a pause at today’s Fed policy meeting, as priced in by the market.

However, today’s Fed meeting is significant as US yields and Dollar have edged lower year-to-date, in line with my expectations that the hawkish pendulum had maybe swung too far.

Moreover, today’s meeting – the first since President Trump was inaugurated – will see four new regional bank Presidents, with an arguably more dovish bias, take over from James Bullard, Esther George, Loretta Mester and Eric Rosengren.

I would expect the Fed’s policy statement to highlight the marginal strengthening in the labour market but also the slowdown in GDP growth in Q4, weak housing data in December and still very modest rise in inflation and inflationary expectations.

The Fed may also chose to emphasise the importance of domestic conditions, indicators and developments when setting interest rate policy, a very subtle nod to the increasingly acute uncertainty which the Fed currently faces.

Finally, the ten voting FOMC members are likely to unanimously vote in favour of rates remaining on hold.

I see no compelling reason why, at this juncture, the Fed would want to guide US yields (or the Dollar) beyond their year-to-date ranges. At the margin, the risk is that the Fed tries to stabilise yields, particularly at the long-end of the curve, with an eye on keeping open the possibility of a March rate hike.

Until the Fed has tangible evidence that macro policy-promises are being enacted and it has conducted an initial evaluation of these policies’ possible impact on the US economy, the Fed may disappoint market participants expecting a marked step-up in the hiking cycle from the one-a-year hikes delivered in 2015 and 2016.

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Federal Reserve – the Father Christmas of central banks

Thursday’s Fed policy meeting contained few major surprises, even if the divide amongst FOMC members has received much attention.

The bottom line is that 14 out of the 17 FOMC members, and at a minimum 7 of the 10 voting members, estimate that at least one 25bp rate hike before year-end would be appropriate.

Should the Fed hike in December – currently my core scenario – this almost unprecedented glacial pace of hikes would be in line with my January forecast of only 1-2 hikes in 2016.

The Fed’s accompanying statement and Yellen’s press conference were, if anything, reasonably upbeat. There were no direct allusions to the dollar, property, equity and bond markets or to global factors, with some justification (for now at least).

The Fed’s two main concerns are squarely centred on sub-target inflation and areas of weakness in the labour market.

It will thus be paying particular attention (and so should markets) to evidence of slack in the US labour market, with the unemployment rate becoming a less useful measure per se of labour market strength and potential wage/price pressures, in my view.

The Fed is clearly giving weight to the historically low neutral Fed funds rate. Even so FOMC members may have to further tone down their 2017-2018 estimates of the appropriate policy rate in relation to realistic (if still a little optimistic) economic forecasts.

Financial markets’ reaction has so far been mostly text-book: a jump in market pricing for a December hike to 16bp, a bull-flattening of the US yield curve, a slightly weaker dollar, a rally in EM and commodity currencies and stronger global equities.

But now comes the hard part. Volatility in Fed fund futures is likely to remain fluid in coming weeks, with financial markets increasingly sensitive to key US data, particularly on inflation and labour markets, speeches by FOMC members and presidential opinion polls.

Should Clinton win the US elections, US data improve and the Fed hike in December, I would expect the dollar to end the year stronger, EM currencies and global equities to struggle to hold onto post-US election gains and major currencies to underperform.

The more problematic scenario for the Fed (and its credibility) is one whereby Donald Trump wins and/or US economic activity slows down.  

This would likely cause a sharp sell-off in global equities while safe-haven assets (e.g. gold, Swiss Franc) would outperform the dollar and in particular EM currencies. Moreover, these moves could struggle to reverse even if the Fed decided to pause in December. Read more

Fed – Sense of déjà vu

Recent US data have likely put a Fed rate hike at its 21st September policy meeting beyond reach, with a post-US presidential election rate hike now the more feasible scenario.

US labour market data for August – sandwiched between very weak ISM prints – suggest that there is still slack in the US labour market. Aggregate weekly payrolls in the private sector rose only 3.5% year-on-year, which in turn is likely taming inflation.

Job creation growth was stable at around 1.9% yoy, which in itself is compatible with a Fed hike in September. But working hours fell in August, earnings growth slowed further and the pool of potentially available workers has now increased for three consecutive months.

These numbers will have done little to convince Chairperson Yellen that the time for reflection is over and the market is now only pricing rate hikes of 5bp and 13bp, respectively, for the Fed’s September and December meetings.

There is a sense of déjà-vu and the path of least resistance is probably for the Fed to keep rates unchanged this month while keeping alive the possibility of a hike on 14th December.

Moreover, the Fed will have the added benefit in December of knowing the still uncertain outcome of the US presidential elections scheduled for 8th November.

The Fed remains apolitical and has in the past hiked rates in the run-up to US presidential elections, but a Clinton victory and a positive US and global market reaction are probably necessary if insufficient conditions for the Fed to hike with conviction.

Should the Fed hike in December, this almost unprecedented glacial pace of rate hikes would be in line with my January forecast of only one or two hikes in 2016.

Financial markets’ reaction to recent US data has been a familiar one – lower rates, weaker dollar and stronger EM currencies and global equities. But it has revealed little about how markets are likely to respond if and when the next Fed rate hike comes into clearer focus.

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Is it a hawk, is it a dove, no…it’s the Fed

It has now been 260 days since the Fed hiked its policy rate 25bp (for the first time in a decade) and all we really know is that, in the words of Fed Chairperson Yellen speaking at the Jackson Hole symposium last week, “the case for an increase in the federal funds rate has strengthened in recent months”. Admittedly some of the more hawkish voting members of Federal Open Market Committee (FOMC), including Vice-Chairmen William Dudley and Stanley Fisher, have more forcefully made the case for a rate hike sooner rather than later.

But as forward guidance goes this is still of limited value beyond the Fed indicating, as it has done throughout most of 2016, that the next move will likely be a hike, rather than a cut, and that it will likely take place this year. As a result the market is still pricing only 7bp of hikes at the Fed’s policy meeting on 21st September and 17bp of hikes (using a weighted average) at its 14th December meeting. Similarly, in a Reuters poll in early August analysts attributed only a 25% probability to a hike in September, versus a 58% probability to a December hike.

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Fed on the ropes but not down

The US Federal Reserve and markets have been engaged in a bruising duel for the past six months. Round 6 should have been an easy one for the Fed given reasonably well behaved equity and FX markets, surging energy prices and signs that global GDP growth was stabilising.

But softer US employment data for May have put the Fed on the ropes, with markets having now all but priced out a hike next week and only pricing in a 24% probability of a hike on 27th July.

The Fed is not down, however, thanks to decent earnings, income and spending, a pick-up in most inflation measures in April and a robust housing market, which all point to a rebound in GDP growth in Q2.

In the labour market, an increasingly high percentage of those who want a job are finding one and the steady share of full-time employees points to decent hourly earnings growth in months ahead. There is still slack but arguably less than in December when the Fed hiked.

The Fed will be hoping that the next data set, particularly for the labour market, manufacturing and inflation, will go its way so that it can finally deliver a second-hike in a decade at its July meeting.

This is still my core scenario, although if labour data for June disappoint the Fed may well turn to its 21st September meeting as its next possible trigger point.

A July or September hike would leave the Fed with another few rounds to hike its policy rate by another 25bps, in line with Fed members’ current average forecast of two hikes in 2016. The Fed will want to show markets that it will not be swayed by soft data punches or temporary market developments and is still in control, but without flooring markets. Read more

US Economy Not at Full Employment

Markets, which tend to focus on US non-farm payrolls and the unemployment rate, may be relying on an incomplete and arguably inaccurate picture of the US labour market which fails to fully take into account a still sizeable pool of available workers.

Job creation has been robust in recent years, but the working age population has also increased while the share of full-time employees remains modest. As a result, the ratio of the working-age population employed in full-time jobs, currently 48.7%, remains well below its historical average.

Importantly this ratio tends to lead the growth rate in private sector employees’ hourly earnings and points to earnings growth only rising modestly in coming months from around 2.4% year-on-year.

The policy implication, all other things being equal, is that the Federal Reserve may not have to worry near-term about a tight labour market boosting pay-packets and in turn wage-led inflation. With US GDP growth having collapsed in Q1, global growth having slowed further to around 2.6% year-on-year and global PMI and Chinese trade data showing little bounce in April, the Fed’s decision to keep rates on hold so far this year is at least defendable.

My core scenario of one or two Fed rate hikes this year remains feasible but my expectation that the Fed would pull the trigger in June will likely be proven wrong. The Fed fund futures market has all but discounted a mid-year hike, currently pricing in a probability of only 8% for a 25bp hike, versus 23% back on 26 April. Read more

Fed pulls off 40-word Houdini

The Fed kept rates on hold yesterday – pretty much a done deal – and its statement yesterday following its two-day policy meeting was very short on new insights.

But it was in line with my expectation that while the Fed would present a marginally less dovish assessment of the global economy, it would paint a still cloudy picture of the US and nurse the recently faltering rally in global risk appetite. US equities closed up 0.3% yesterday and 2, 5 and 10yr US treasury yields are down 6-10bps since Tuesday.

The Fed faces seven rocky weeks ahead of its 15th June meeting. It will likely want to keep the door ajar for a hike and will therefore not want to see US yields break out of range. But the market’s violent reaction today to the BoJ’s unchanged monetary policy is also a stark reminder that an overly-hawkish Fed could derail global risk appetite and in turn delay any Fed hikes.

With this in mind, my core scenario of a June hike is likely to be tested in coming weeks and the risk remains that flat-lining emerging market currencies will come under pressure. Read more

It’s a Fed hiking cycle Jim, but not as we know it

Tomorrow’s Fed policy meeting decision is unlikely to throw up any surprises, with the market having priced out any chance of a hike. The real focus will be on the language of the accompanying statement.

The market has arguably already priced in the possibility of a slightly less dovish Fed, with US yields at a one-month high. The US labour market remains robust, inflation expectations have ratcheted up, as have house prices. Chinese economic activity has picked up and global equities and commodity prices have surged in the past couple of months.

But the Fed is also likely to reiterate its concerns about slowing global growth, US business investments and exports and the headwind to US growth from the manufacturing sector. This nuanced picture is summarised in the heat-maps in Figures 5 & 6.

Moreover, the Fed has made clear it would look beyond potentially temporary developments and could well play down the recent rebound in global energy prices and in major economies such as China.

I therefore expect the Fed to be constructive enough tomorrow to keep US yields in reasonably narrow ranges but to stop short of encouraging a significant repricing for a June hike.

This remains a challenging balancing act for the Fed as equity markets and non-commodity currencies have been flat-lining recently. If the Fed intensifies its dovish warnings, markets could start looking more closely at what is keeping the Fed from delivering only its second hike in a decade. Conversely, a more hawkish stance could spook a market attuned to dovish Fed rhetoric.

My core scenario remains for the Fed to hike rates once or twice this year, which would be sufficient to expose the soft under-belly of EM currencies. Read more

Right said Fed

The Fed left its policy rate unchanged at 0.25-0.50%, as expected, and the 10 voting Federal Open Market Committee (FOMC) members and 7 non-voting members halved their median expectations of rate hikes in 2016 from four to two in their updated projections (see Figure 1). The Fed’s statement, projections and press conference had an undeniably cautious tone, with clear focus on global risks. The rally in US equities (to a new 2016-high) and 2-year rates (to a March low) and further depreciation in the dollar post meeting clearly indicate markets’ dovish interpretation (see Figure 2). Read more

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