Is the Fed a ‘No Go’ after Service Activity drop?

Wednesday September 7: Five things the markets are talking about

Have investors got the proof that the Fed normalization policy remains on hold for this month’s meeting?

Last Friday’s soft non-farm payrolls report had already dented the ‘hawks’ case for a September Fed hike, but yesterday’s six-year low print in U.S Services ISM may have delivered the decisive blow.

Fed funds futures are now pricing in less than a +15% chance of a move later this month, yet, the probability of a U.S rates backing up by year-end remains above the +50% benchmark.

For the ‘doves’, with the U.S economy treading water, they do not expect the Fed wanting to create any waves with a September rate hike and they are currently winning the battle as the ‘big’ dollar comes under renewed pressure, unwinding some of its rate differential premium across the board.

1. Equities get a boost from disappointing service sector

Global equities have hit a one-year high overnight as expectations of a rise in Fed interest rates continue to recede.

It’s no surprise to see Emerging Market shares leading the charge as investors covet yield with global interest rates likely to stay low for a prolonged period. The exception in Asia is the Nikkei 225 (down -0.4%); it closed under pressure as the dollar plummeted against the yen (¥101.64), making Japanese exports more expensive.

In Europe, regional bourses remain close to their highs ahead of the U.S open. The Stoxx 600 index fell -0.2% led lower by banks – lower interest rates promise tougher times for financials. However, a weaker dollar is supporting the energy sector and this despite many market participants remaining doubtful that producers would reach a deal to freeze output later this month.

Indices: Stoxx50 +0.3% at 3,080, FTSE flat at 6,823, DAX +0.2% at 10,709, CAC-40 +0.2% at 4,537, IBEX-35 +0.6% at 8,954, FTSE MIB +0.4% at 17,122, SMI -0.3% at 8,283, S&P 500 Futures flat

2. Crude bulls breath a sigh of relief

Trading crude is not for the faint of heart. Brent rallied just shy of the psychological $50 handle Monday on a Saudi/Russian deal that looked like a partial solution to the global glut problem. However, curtailing production in the short term was dismissed by the Saudi energy minister, and with that, most of the Labor Day price premium.

Weaker U.S data is now providing support for energy and commodities via a weaker U.S dollar.

Brent crude (November) is trading up +35c to $47.61 a barrel. It rose as high as $49.40 on Monday. WTI is up +49c to $45.32 ahead of the U.S open.

Expectations of low rates for longer are good for gold. With the dollar on the back foot the precious metal has managed to rally to its highest level in a week ($1,353.00).

Metal prices are likely to remain firm for the next few weeks, though, the market does believe that rate rises are coming eventually, and that there will become a price resistance factor as we move higher.

3. Short sterling pain

One of the most popular trades since the Brexit vote has been “short” sterling. GBP fell by as much as -14% after Britain voted to leave the EU on June 23.

However, with a plethora of positive U.K. economic data post-Brexit has managed to send the pound surging, threatening to upend the markets £6B short bet (August 30 there were 94,486 more short sterling futures contracts).

The pound has jumped by +2.24% outright since last Thursday when better than expected manufacturing survey data started the currency on a roll that was extended this Monday with positive numbers from the service sector. This stronger growth data would suggest that it takes the BoE out of the equation next week (September 15).

Where to from here as both the bears and bulls need guidance?

Later this morning, BoE’s Carney will have the opportunity (9:15am EDT) to defend the “old Lady’s” aggressive easing stance despite the recent strength in economic data.

Sterling ‘bears’ say that it’s too early to be sounding the all clear on Britain’s economy as the country has yet to begin negotiations with the EU, its biggest trading partner. The ‘bulls’ will point to the data and a hesitant BoE to justify a stronger pound. Will Carney burst their bubble?

4. Yields plummet again

U.S government bonds have strengthened dramatically following yesterday’s weaker-than-expected report on non-manufacturing economic activity.

The yields on U.S 10’s have fallen from +1.604% just before the report’s release to +1.539% this morning. Federal-funds futures are pricing in a +15% likelihood of a September rate increase.

The market may get more clues on the Fed’s view on rates this morning, when Richmond Fed President Lacker and Kansas City Fed President George testify at the House Financial Services panel on ‘Governance, Monetary Policy and Economic Performance’ at 10 am EDT.

Euro zone government bond yields are also under pressure (10-year bunds yields tumbled more than -2 bps to negative -0.1%), as a ‘no’ action FOMC could pressure the ECB to ease monetary policy further.

However, tomorrow’s ECB meeting has probably come too soon, nevertheless, if Draghi does not act, investors should expect to hear about their willingness to ease.

5. Sweden’s Riksbank unchanged

Sweden’s Riksbank left its expansive monetary policy mix unchanged earlier this morning to keep the SEK from appreciating against the EUR and to revive inflation, which has been slowly gaining pace.

Benchmark interest rate would remain at minus -0.5% and its bond-buying target would remain at SEK 245B by the end of 2016.

The Riksbank is one of the NIRP central banks (EUR, JPY, DKK and CHF) that have taken the unorthodox move of cutting interest rates below zero to steer exchange rates and boost economic activity.

Currently, the fixed income market is not pricing in any major changes to the Riksbank’s stance for the remainder of this year.

There were marginal revisions to the bank’s macro forecasts, with expected inflation in 2017 rising to +1.9% from +1.8%, while the GDP forecast for 2016 was lowered to +3.2% from +3.6%.

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