View from the FX Dean: Wednesday September 16, 2015
Forex traders can expect tight range bound, but whippy trading, to continue until tomorrow afternoons Fed announcement (2pm EDT). Dealers are now bracing themselves for some sharp post statement swings no matter what the message will be. Despite the “standing pat” leading the vocal charge, it remains a coin toss on the outcome. Nevertheless, should the Fed surprise with a rate hike it would leave the dollar most vulnerable to a large burst out of the recent ranges. It’s not what the Fed does, but says and implies that will have the biggest impact on traders dollar positions.
For the majority, the market risk-reward is not to have any significant positions on board ahead of the announcement. The prudent investors will have already waded to the sidelines and is now waiting to see how the Fed decision pans out before contemplating participating again. A hike may initially hurt bonds and equities, but a “dovish hike” – a hike with a gradual tightening path – may actually support these riskier assets in the longer term. Remember, it’s not what they do – 25bps or less should not matter to anyone – but what they say. Investors want to be reassured that future rate increases will “only be very gradual” in nature.
Yesterdays headline for August U.S retail sales missed expectations (+0.2% vs.+0.3%) and even fell short of the expected gains seen in the revised July data (+0.7%). Nevertheless, the markets focus was always on the elements that affect growth aka U.S GDP. They happened to beat expectations, with the June and July reports both revised higher. Along with last month’s industrial production data, whose headline was a tad weaker (-0.4% vs. -0.1%) but coupled with stronger July revision (+0.9%), the U.S economy remains on track to register a growth rate of +2.5% for Q3.
The “good as or better” perception for U.S growth managed to push U.S short term yields to new four-year highs yesterday. Two-year debt now yields +0.80%. With short-yields so vulnerable to the Fed’s decision tomorrow, yields could fall if Ms. Yellen and company decide to hold rates steady. Fixed income traders do not expect rates to remain too low for too long, as the market will be immediately switching their focus to Fed rate decisions in October or December. If Fed does happen to tighten, dealers will automatically shift their focus to the longer end (U.S 30-years) and push those rates up also. The impact could be limited, as spec buyers will sure to appear on concerns that a higher rate policy may hurt the world’s largest economy. From a technical perspective, two-year yields remain relative low from a historical standpoint. Higher yields continue to support the USD. Even if the Fed holds the greenback yield advantage is expected to remain intact as tightening expectations would simply pushed to later in the year.
There are a multitude of reasons for the Fed to hold the status quo. Here are a quick seven:
1. U.S inflation continues to run well below the Fed’s target and has done so for three-years.
2. The USD is surging, as measured by the Fed’s trade-weighted index.
3. A majority of market participants are not expecting a hike this month. Will Ms. Yellen want to upset them and perhaps cause more financial instability?
4. Fed funds futures are reflecting a +28% possibility for higher rates. Still relatively high, but its less than a few weeks ago when it was at +54%.
5. A couple of Fed speakers (Dudley and Williams) have stated that the U.S economy is showing an “amber light, not green.”
6. There is time in October and December for the Fed to carry out Yellen’s wishes – The Fed chief has been very vocal about beginning the rate normalization policy before the end of 2015.
7. With global economies haven taken on too much U.S debt, any Fed tightening will cause financial disruption to these weaker economies.
Earlier this morning, U.K labor data has come in better than expected, supporting speculation of potential BoE action. U.K Wages grew at their fastest pace in more than six-years (+2.9% vs. 2.5%e) and the unemployment rate unexpectedly fell (+5.5%), suggesting that U.K inflationary pressures are building in the labor market. This is supporting the pound in early trading (£1.5416).
Rate differentials remain the order of the day and are putting the euro (€1.1234) under some pressure in early stateside trading. A number of ECB members continue to drop hints of the possibility of an extension or expansion to their asset purchase program. The latest is ECB’s Constancio (Portugal) stating this morning that there is scope to increase QE if necessary, the scheme was small (+€1.1T to September 2016) compared to similar Fed, BoE and BoJ programs.
Japan’s debt ratings were reduced at S&P over doubts the government will revive economic growth and end deflation in the next two to three years. The country has ¥54t of debt outstanding. The ratings were lowered to A+ from AA-. Whilst remaining at investment grade, perhaps a reason for the BoJ to introduce more stimulus next month? ($120.41)
The OECD has cut both its 2015 and 2016 global growth forecasts. This years global GDP has been moved from +3.1% to +3.0% and 2016 from +3.8% to +3.6%. Commenting on the Fed, it was the “scale and not timing of Fed moves” what matters; an early move would remove some of the market uncertainty and promote financial stability. On China, they acknowledged that growth dynamics were difficult to assess and the possibility of a larger slowdown could be a global risk.