The Big Market News Week Lives Up to the Hype

China joined the SDR, with a fat that puts it in third place behind the actual dollar and euro.  The actual ECB did ease policy. This delivered a 10 bp cut in the deposit rate (right now -30 bp), extended its asset purchase program for six months (to March 2017), broadened the range of assets that can be bought to include regional bonds, and declared motives to reinvest maturing proceeds.

The All of us employment data removed what was perceived as the last potential challenge to Fed decision to hike rates later this month.  Not only was the actual headline number a little stronger than expected at 211k, nevertheless October jobs growth was revised to almost 300k. 

The internals were also generally favorable though the underemployment (U-6) did tick up, but continues to be at its lowest level since 2008, except for October.  The breadth of job increases (industries) was the best within nine months.  The number of individuals quitting their jobs appears at a four-month high, and this coupled with labor shortages reported in the Beige Book, suggest reasonably good prospects for increased wage pressure.

The markets have a excellent degree of uncertainty removed.  The BOJ balance sheet is expanding at an incredible clip associated with JPY80 trillion a year, and Governor Kuroda sees no compelling reasons up the ante further.  In fact, because of more recent data, especially funds expenditures, Japan's GDP, which contracted in Q3, is likely to be modified to show a little growth.  The actual ECB reviewed its monetary coverage and targets.  It made adjustments and barring a substantial shock, is unlikely to review it again until toward mid-2016. The financial institution of Canada and the Book Bank of Australia have recently reaffirmed their steady course.

The Reserve Bank of New Zealand, the Swiss National Bank and the Bank of England meet in the week ahead.  A Bloomberg survey found 15 of 18 economists expect the RBNZ to cut the cash rate by 25 bp, bringing it to 2.50%.   The vast majority expect this to become the last cut in the period.  We suspect there is a greater chance than suggested through the survey that the central bank stands pat.  Ideas that the RBA's neutral stance, the small move by the ECB, and elevated confidence of a Fed backpack, may steady the RBNZ's hand helped spur almost a 1% rise in the New Zealand dollar before the weekend. 

Draghi, Constancio, and others at the ECB blame market participants for that second largest single day rally in the euro (the first being when the US announced QE within March 2009) and the razor-sharp backing up in interest rates.  Nevertheless, the Swiss National Bank was probably as surprised anyone.  The sense of urgency that Draghi seemed to express plus some trial balloons apparently launched, likely spurred SNB officials to prepare for that worst.  What was actually shipped, and the market's response, take pressure off the SNB from going further down the rabbit pit of unorthodox policy. 

With the Swiss economy stagnating in Q3, deflationary demands (CPI -1.2% year-over-year in October), and list sales contracting in 9 of the first ten months of the year (year-over-year basis), a case can be made for easing monetary policy.  However, the sight-deposit target rate is currently minus 75 bp.  Neither is the currency exerting a lot pressure.  The franc was trading at five-year lows against the dollar before last week's correction.  Against the euro, the franc inside a lower range that has been set up since late August (for the euro, it is CHF1.0750-CHF1.1000).

The Financial institution of England is the least likely to surprise.  Policy is on hold though there can always be one (and only 1) MPC member that is resisting, favoring the hike. There have been four macro-developments for that MPC to consider.  There has been a further stop by the price of oil.  There is more confidence that the Fed will hike rates this month.  The ECB eased. Sterling had valued 4% on a broad trade-weighted measure from the mid-October through mid-November.  The consolidation gave way to a pullback, leaving sterling still about 2% higher. 

Earlier this year, there were times when the market seemed more confident of the BOE rate hike than a Fed hike.  Now it is quite a different story.  By the time the BOE provides its first hike, the actual Fed, even in a gradual setting, may lift the interest price target by 50-75 bp.  

However, is really a December rate hike through the Fed a done offer?  How can the December Given funds futures, which Bloomberg yet others calculate to imply only a 74% chance, be reconciled with surveys that suggest 90% or more expect the hike?  The key is the assumption associated with where Fed funds average after lift-off.  Models assume that it will likely be in the middle of the Fed money range.  This need not be the situation.

If the Fed wants to clarify the point of gradual tightening as well as maximize its control of extra reserves, it may choose to supply sufficient liquidity to keep the Fed funds rate underneath the middle of the target range.   If a person assumes that Fed funds will average 31.Five bp instead of 37.Five (the middle of the anticipated brand new range), a hike has been completely discounted.   Because of the risk that Fed funds do not average the middle of the range, the December Fed funds may not completely discount a hike under the conventional approach. 

We dispute claims that the dollar's move is over because the divergence of monetary policy has all been discounted.   Consider that according to Bloomberg, the market has discounted a 40% chance of another hike in March.  Given the Fed has signaled, through it’s dot-plots, which will update in a couple of days that a hike once a 1 / 4 or every other meeting is projected to be appropriate, the risk seems greater and not just about all priced into the futures remove. 

At the same time, the high frequency economic data due out in the coming days, including import prices, wholesale and business inventory figures, producer prices, and even list sales, is unlikely to impact either expectations for the Fed's 1st or 2nd rate hike.   An irony not lost on numerous participants last week was because Yellen and other Fed officials discussed their confidence in the expansion, the Atlanta Fed's GDPNowcast for Q4 has been halved to 1.5% in the last month.  

Policymakers put more focus the signal generated from household final demand, accepting that the weak foreign growth and also the drag from the dollar's understanding are temporary. The drivers of the inventory cycle, which still has a strong influence on short-run growth, extend beyond monetary coverage.  Household consumption drives 2/3 from the economy and continues to broaden by 2.5%-3/0%.  Moreover, the effectiveness of consumption and services helps the economy weather the actual headwinds hitting the industrial sector. 

Great uncertainty remains over the outlook for China's policy.  Now that it is in the SDR many expect Chinese language officials to intervene less on the currency, with some thinking that devaluation in August was just the "first bite of the cherry, the second bite is coming. Other people argue that foreign central banking institutions will begin boosting their yuan supplies soon, and this will provide the offset to the private capital outflows.   Addititionally there is speculation that China will raise the band in which it allows the dollar-yuan trade rate to move (2% from the central reference rate, or repair). 

There is scope for the PBOC to ease monetary policy.  There are numerous financial reports that will be released in the days ahead.  Ironically, they are accepted with less cynicism than the GDP figures.  Of the reports, traders tend to watch the CPI as well as trade figures the closest.  The far east expects to report a record trade surplus, which is one of the arguments against a significant depreciation of the yuan.  Exports and imports are still getting on a year-over-year basis. 

China's CPI continues to be stable this year.  It has averaged One.4% year-over-year through October, and it is likely to match it in November.  This means policy rates stay too high.   High reserve needs may have been a macro-prudential tool in a period of strong capital inflow, however 17.5% rate now appears ill-suited for a period of capital outflows.  Even if the precise timing may be impossible forecast with any confidence, the bottom of China's monetary cycle is not at hand. 

What does this mean for that dollar?  The divergence of monetary policy remains very much in place, and that we think it is not fully priced in, and we wonder if it truly can be discounted.  We see the price action as an arguably long-over correction to a move that began in mid-October.   The extent of market position had left it vulnerable to a buy (dollar) rumor, sell the very fact even if the ECB had not disappointed.   

Until we’re closer to the peak in the monetary divergence, the main dollar driver, it is not easy to call an end to the 3rd significant greenback rally since the end of Bretton Woods.  With regard to medium and long-term investors that broadly agree with this evaluation, this pullback in the dollar may be the kind of opportunity that has been awaited and anticipated.  That said, a dollar decline is the pain trade, but given the sharp move in US stocks in front of the weekend, recouping everything this lost in the previous day's ordeal, and then some, it is the holiday season as well as investors prefer pleasure in order to pain.

This can make for choppy conditions and prevent a new pattern from emerging immediately. The actual dollar bulls have been scared (psychological) and scarred (material losses), and will be reluctant to jump back in immediately.  The bears might be more opportunistic than true believers and would want to squeeze much more bulls.  However, they do not want to overstay their own welcome, with a Fed backpack looming, and the low-hanging fruit–the weak dollar longs–have already been picked.

After Gorging On Information, Time To Digest is republished with permission from Marc to Market