US Treasury yields pulled back yesterday from their extreme pricing of earlier in the week after four Fed members made their current thoughts known ahead of Chair Powell speaking this afternoon at the annual Jackson Hole symposium.
While a couple of participants preferred a 50bps cut there were also several participants who favoured ‘maintaining the same rate’. Thus, the minutes offered little for the doves and continued to frustrate and drive Trump to twitter again overnight as he continues to see a Fed falling short of his suggested of 100bps of cuts over a ‘fairly short period of time… with perhaps some quantitative easing as well’.
The US Treasury market rallied across the curve yesterday as geopolitical tensions intensified with the attack on the two oil tankers in the Gulf of Oman.
The short-end of the market is now pricing in three 25bp cuts to the funds rate this year and then nothing more, which is a little strange. Some argue for an ‘insurance cut’ as early as next week’s FOMC meeting sighting the Middle East situation…
The FOMC minutes of their August meeting were released last night which caused a limited reaction in asset markets. The Treasury market rallied modestly and the USD weakened as the minutes were initially released, with headlines suggesting that the Fed saw trade and slowdowns in emerging markets economies as downside risks to the outlook.
Over the past week the term spread between 2-year and 10-year US Treasuries has averaged 25bps – equivalent to just one more Fed rate hike. Also earlier this week the 3-month Treasury bill yield touched 2% for the first time since 2008; this means that even short-term bonds now yield more than US stocks for the first time in a decade – becoming a viable alternative for those apprehensive about both stocks and bonds.
Its Jerome Powell’s first policy meeting as Fed Chairman; and with the near certainty that rates will be raised to 1.5-1.75% everyone is really now only interested in what the man has to say about the effects of stimulus in an already tight labour market, inflation concerns, and any sign that the Fed is playing cautious in the early days of Powell at the helm. Currently implied probabilities show around 40% expect 3 quarter-point-rises this year with the remainder evenly split between expecting more or less than 3 hikes.
Last night we received the minutes from the FOMC meeting in May which proved to be a little more ‘dovish’ than expected regarding interest rate policy. While most voters still saw tightening as likely to be appropriate 'soon,' other voters felt it was prudent to wait for further evidence that the first quarter slowdown was transitory. The Fed expected consumer spending to rebound in coming months, however, a few members voiced their concerns that the progress towards the Fed’s inflation goal had slowed.
In a clear case of ‘sell the rumour, buy the fact’, the FOMC raised the Fed's funds rate target by 25 bps last night sparking a rally across the US Treasury (UST), stock, emerging market forex, Latam, Middle East and Far East bond markets.
The rate hike was followed by a much more dovish Fed statement than was previously expected. In the post announcement press conference Fed Chair Janet Yellen stated, ’It is likely that target policy rates will go up in line with their forecast.
The FOMC decided to raise the fed funds rate to 0.75% on December 14th, and have pencilled in an extra rate hike in 2017. The media would have us believe that the faster pace of normalising the policy rate to its long term norm now estimated at about 3% reflects both a stronger US economy and expectations of outsized fiscal stimulus under a Trump presidency. An upward revision to Q4 GDP also tends to have some carry-forward into the Q1 level of GDP in the staff’s forecast exercise, thereby explaining the small 2017 revision.
As widely anticipated, with just 6 days before the US Presidential Elections and without a scheduled press conference, the FOMC held off raising rates at least until the next meeting on December 13-14. This now means that it will have been a whole year since the last Fed rate hike last December back when markets were pricing in 4 rate rises in 2016. Now there is only a 78% expectation that there will be just one hike, although this is up from the 70% expectation of Fed action prior to the release as ‘the case for an increase in the federal funds rate has continued to strengthen’.
With central bank week in full swing we look back to our daily last week where we mentioned that our most likely scenario was for the BoJ to move to steepen the JGB curve and the Fed to remain on hold. Yesterday all eyes were on the Fed, after hearing that the BoJ had launched “QQE with Yield Curve Control”, or Quantitative and Qualitative Monetary Easing with 10-year yield control at 0%; intended to steepen the curve. Also as expected, the Fed maintained status quo; leaving a hike in December on the table.
Last night we had the minutes of the FOMC July meeting, where members of the committee generally agreed that more data was needed before the US should consider raising rates, however the timing of any move remains an issue. There seems to be two trains of thought within the committee though, with some of the members wanting more evidence inflation would rise toward target before a hike, however others were concerned low rates could have a negative impact on financial stability, stating that a prolonged period of very low interest rates might cause investors to misprice risk, leading to the destabilising of financial markets.
The FOMC maintained its interest rate status quo by holding rates again yesterday, this time round with one dissent. The only significant upgrade to the economic assessment was, “Near-term risks to the economic outlook have diminished.” This comment suggests the Fed is gearing up to resume the normalisation process, however there was little guidance that lift-off will take place at the next meeting in September. The US Treasury curve bull flattened after the announcement as market makers favoured the long-end of the curve, and the dollar has remained softer against major currencies today.
As the Brexit effect continues to ripple through markets this week, sovereign bond yields have rallied to fresh lows and the US Treasury curve continues to flatten. Historically such aggressive falls in yields and the extent to which the US curve has flattened have indicated an approaching recession; we think it is a bit too early to call for a recession at this stage as moves have been amplified by global financial market uncertainty. However, we do not see any upside pressures in the short-term as concerns over global stagnation and further weak to mixed economic data will no doubt dampen already fragile market sentiment. In fact, the relatively cautious minutes from the June FOMC meeting released yesterday indicate a further delay in rate hikes and an even more gradual pace to future rate rises, with repeated reference to the “uncertainty”.
Today’s non-farm payroll data release for May recorded 38,000 jobs added which was well below expectations of 160,000 and compares with a downwardly revised 123,000 jobs added in April. The two month payroll net revision was -59,000. The 3 month average for job creation is now running at only 116,000 jobs. The unemployment rate fell to 4.7 percent however the participation rate edged down to 62.6 percent. Average hourly earnings was unchanged at 2.5 percent yoy against expectations of a 2.5 percent yoy increase and average hours worked edged down to 34.4 from 34.5 the prior month.
As Volkswagen’s litigation nightmare ensues, Norway’s sovereign wealth fund (the largest in the world, at USD 850bn) announced earlier this week that it is looking to sue the company over the emissions scandal.
With high expectations for the BoJ to ease further after the recent strong rally of the yen and weak core inflation readings, the central bank left its three key easing tools unchanged catching some investors off guard. The central bank’s inaction did little to help the continued strength of the yen which breached the ¥108 level today (in London trading hours), soaring ~3% against the dollar.
After a couple weeks of hawkish comments from Fed members, Fed Chair Yellen stepped out for the first time since the last FOMC meeting mid-month and remained true to herself; maintaining her dovish credentials. A cautious approach in adjusting policy was the theme of her speech which she delivered at the Economic Club of New York yesterday. She highlighted that a cautious stance is “warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric”. Like us, she noted that domestic inflation is “somewhat more uncertain” adding that although there have been signs of pick-up, US economic indicators remain “somewhat mixed”. With increasing global uncertainty, Yellen even discussed the central bank’s “considerable scope” to ease if the economy falters, “we used them effectively to strengthen the recovery from the Great Recession” and would do so again, adding that “only a modest degree of additional stimulus” can be provided.
Happy St. Patrick’s Day! Once considered a strictly religious holiday in Ireland, with pubs closed nationwide, in 1970 the law was overturned and the stout was poured with pride!
As we had expected, the FOMC did not move to raise rates yesterday, and in fact surprised the market with its more dovish than expected stance; revising the dot plots down to two (and a quarter) rate hikes this year from four back in December, the median dot is now at 0.875%. The benchmark 10-yr UST climbed to 1.997% ahead of the meeting, falling ~10bps by the end of the session. On balance the US economy has shown signs of stability and in some sectors, i.e. the job market, further strength. What continues to remain of concern to the central bank members is the spillover from “global economic and financial developments” which have recovered somewhat off the lows seen earlier this year.
As we start the new week markets have been relatively quiet, which is somewhat expected given the big moves witnessed post the ECB meeting last Thursday. At that meeting the ECB announced it was cutting the main refinancing rate to zero, further reducing the deposit rate to minus 0.4% as well as expanding QE to EUR80bn a month. At the press conference after the announcement Mario Draghi, the ECB Head said “Rates will stay low, very low, for a long period of time and well past the horizon of our purchases”. When grilled about how low rates could actually go he said “From today’s perspective and taking into account the support of our measures to growth and inflation, we don’t anticipate that it will be necessary to reduce rates further. Of course, new facts can change the situation and the outlook.” Along with the ECB actions last week, tomorrow we have the Bank of Japan (BoJ) Monetary Policy Statement, where the market anticipates no changes to the policy rate after the committee’s decision to move into negative rate territory at the last meeting. Haruhiko Kuroda, the BoJ Governor’s press statement may make for interesting reading.