Markets await Fed’s interest rate decision

NBK MONEY MARKETS REPORT

Last week started with the Italian referendum result yielding the opposite impact to what most investors would have expected. The ECB by Thursday added to the confusion by announcing a €20 billion reduction in asset purchases to €60 billion a month from April 2017at the same time extending the program to December 2017. The market quickly realized it was a clever way of keeping a dovish tone even if scaling back, especially as they made it quite clear that they could increase it at any point to respond to events.

Moreover, Draghi’s press conference was as dovish that the euro remained near the lows of the year. He also said that ECB staff economic forecasts for euro area inflation averaging 1.7 percent in 2019 were “not really” close to their mandate of just under 2 percent.

Simultaneously during the week, three Fed speakers, New York Fed President William Dudley and his Chicago and St. Louis counterparts Charles Evans and James Bullard said at separate events that they were close to achieving their dual mandate of full employment and 2 percent inflation which in turn leaves little doubt about the outcome of the next FOMC meeting. Dudley said that US election of Donald Trump has created considerable uncertainty over the policies he will pursue. Consequently, it was too soon for the Federal Reserve to judge whether its plan for gradual interest rate hikes needs adjusting.

All eyes turn this coming week to the US Federal Reserve on Wednesday. Fed futures prices showed a 97 percent probability of an interest rate hike by the end of this week. Moreover, markets are pricing in over 50 percent chance of another hike by June 2017. However the probability could change in response to what policies Donald Trump would push next year once in office.

As mentioned earlier, the political risk In Europe continues to increase with Italians massively rejecting the need of constitutional reforms. As a result Italian Prime Minister Matteo Renzi resigned following the defeat. The rejection of the people could potentially threaten the country’s unstable banking system. The “No” vote had overwhelming won the referendum with nearly 60 percent of Italian voters rejecting Renzi’s constitutional reforms. It is now up to the Italian President to decide the next move. He could piece together a government out of the current Parliament or call for a general election. The populist Five Star Movement had demanded a snap election, which polls indicate it would win, and continue to pledge to hold a referendum on Italy’s EU membership.

Moreover, financial markets have seen the outcome of the referendum as a big negative threat for the European Union causing more uncertainty to the country’s banking industry. Indeed, the first victim was revealed this week being Italy’s oldest bank moving in a downward spiral after the ECB has rejected its request for more time to raise capital.

Following Britain’s vote to leave the European Union in June and Donald Trump’s victory in last month’s US presidential election and now Italy rejecting political and economic reforms, the global political arena continues to be extremely sensitive in a time where the Federal Reserve prepares itself to raise interest rates next week.

On the currency front, the euro initially rose following the European Central Bank press release, as investors thought that the ECB was reducing its quantitative easing program. However, markets quickly realized that the net result of the bank’s decisions was negative for the currency, since extending the easing program to December is more than the six month extension that markets expected. This quickly forced the Euro down against its major counterparts. Its needless to say that the Union state will be closely linked to a chain of political events in Europe in 2017. Elections in Netherlands, Germany, and France might open up the chance for the populist sentiment that is taking a hold of Europe to have a stronger foothold in the political scene.

The Euro currency opened the week at 1.0672against the US Dollar and managed to reach a short lived high at 1.0872. The pair-closed the week near the lows of 1.0565.

The Sterling Pound opened the week at 1.2725 and reached a low of 1.2545 against USD. However, the Pound recovered as hopes that the UK Government might seek a soft “Brexit” whereby the UK pays to remain in the single market once it has left the European Union. The currency managed to close the week at 1.2578.

In Asia, the USDJPY managed to reach a high of 115.44on speculation the Japanese economy would face pressure from US President-elect Donald Trump’s plan to withdraw the US from any multinational trade deal and on potential implementation of protectionist policies. Although expectations Trump will increase fiscal spending and set US growth on a higher gear were seen as a benefit to Japan, concerns around trade policy under the incoming administration highlighted the world third largest economy’s dependence on exports. The pair closed the week at 115.40.

US manufacturing

The US ISM non-manufacturing index climbed more than expected in November from 54.8 to 57.2. The increase was driven by business activity, employment and deliveries. This is the highest level in 13 months. Overall, ISM non-manufacturing survey brought a positive surprise and suggests that the services sector is growing at a comfortable pace. Taken together with the ISM manufacturing survey released last week, which was also better than expected, the composite level of ISM manufacturing and non-manufacturing is consistent with GDP growth being above 2 percent yearover-year.

US trade deficit

The US trade deficit recorded its biggest expand in more than one and a half years in October as exports of soybeans and other products fell, suggesting trade would be a drag on growth in the fourth quarter. Trade deficit expanded to $42.6 billion in October from $36.2 billion in previous month. Higher imports due to rising domestic demand also contributed to the widening of the deficit. When adjusted for inflation, the deficit rose to $60.3 billion from $54.2 billion in September.

The number of job openings was little changed at 5.5 million on the last business day of October, dropped from 5.6 million in previous month. The job openings rate was 3.7 percent in October. However, the unemployment claims came at 258,000, a decrease of 10,000 from the previous week’s unrevised level of 268,000. The 4-week moving average was 252,500, an increase of 1,000 from the previous week’s unrevised average of 251,500. This marks 92 consecutive weeks of initial claims below 300,000, the longest streak since 1970.

Europe & UK

The European Central Bank said in a press release that its Governing Council decided to keep its interest rates unchanged, in line with expectations. The council also decided to maintain its asset purchase program at the current monthly pace of €80 billion until the end of March 2017. However, the program will be reduced to €60 billion starting from April 2017, and its running period will be extended to December 2017. The press release did not rule out the possibility of lengthening the program’s period further. The extension would add a total of 540 billion Euros to its current 1.7 billioneuro stimulus, making the size of the program double what the ECB initially announced it in January 2015. By extending bond purchases but reducing the monthly pace, the ECB may be trying to preserve its extraordinary monetary stimulus as political risks cloud the outlook for the euro area’s recovery.

Europe PMI

The rate of eurozone economic expansion accelerated to its highest in the year to date during November. Although still well in expansionary category, the eurozone services and composite PMI reflected marginal softening. Eurozone Services PMI dropped slightly to 53.8 from 54.1 in October. The figure came marginally weaker than market expectations.

On other hand, German service providers enjoyed a further month of solid output growth, with the latest increase the most marked in six months. Increased activity was driven by new business wins which continued to expand strongly. With business outstanding rising for the first time since June, companies were encouraged to raise their workforce numbers further during the month. Germany Services PMI Business Activity rose from October’s 54.2 to a six-month high of 55.1 in November and thereby signaled stronger growth of business activity.

Germany factory orders

Germany factory orders grew at the fastest pace in more than two years in October, indicating strong economic activity at the end of this year. In details, factory orders grew 4.9 percent month to month in October, reversing a 0.3 percent drop in September. In conclusion, manufacturing has gained momentum in autumn, which suggests that in the fourth quarter German economy is growing at a considerably quicker pace than in the previous quarters.

UK services

UK services sector activity showed an unexpected improvement and surprised markets to the upside in the month of November. The services PMI accelerated its pace of expansion to 55.2 in November from 54.5 in previous month. The rebound marked the highest levels in ten-months, highlighting the underlying strength of the economy at a time of huge political uncertainty. Certainly the economy has held up much better than expected in the wake of the Brexit referendum outcome. The UK data continue to surprise to the upside, and this services PMI reading is no exception, pointing to another good quarter and strong end to the year for the all-important service sector. This can be attributed in part to the fact that the UK is yet to trigger Article 50, meaning that nothing has changed yet, while the fall in sterling has heightened the UK’s international competitiveness.

On a different front, UK manufacturing production fell by 0.9 percent on the month to October 2016, following an increase of 0.6 percent in the earlier month. The drops were broad-based across the sector, with the largest downward pressure coming from pharmaceuticals, which fell by 3.6 percent. Manufacturing month on same month a year ago decreased by 0.4 percent in October 2016. The largest downward contribution came from pharmaceuticals, which fell by 9.4 percent. There were some increases partially offsetting the decreases, with the largest upward contribution coming from other manufacturing, increasing by 10.4 percent.

RBA keeps rate unchanged

The Reserve Bank of Australia decided to leave the cash rate unchanged at 1.5 percent, noting that “taking account of the available information, and having eased monetary policy earlier in the year, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.” The RBA noted that, commodity prices have risen over the course of this year, reflecting both stronger demand and cut backs in supply in some countries. The higher commodity prices have supported a rise in Australia’s terms of trade, although they remain much lower than they have been in recent years. The higher prices are providing a boost to national income.

Chinese consumer price index increased by 2.3 percent year over year in November, slightly above the market expectations of 2.2 percent and the fastest pace since April. Food prices climbed 4 percent year over year and non-food prices 1.8 percent. The Producer Price Index climbed by 3.3 percent y/y, the highest since October 2011, thanks to high commodities prices. The consensus estimate was for an increase of 2.2 percent. Producer price deflation has been abating all year as the economy continued to absorb spare capacity. Producer prices first turned marginally positive in September and have remained on the right side of growth ever since.

Japanese GDP dropped

Gross domestic product came at 0.3 percent in the September quarter of this year, just half of the 0.6 percent growth rate expected by market. The GDP Deflator fell 0.2 percent, also two times worse than forecasts, which had promised a drop by just 0.1 percent. As for positive news, the seasonally adjusted current account widened from ¥1.48 trillion to ¥1.93 trillion in October, exceeding the median forecast.

Kuwait

Kuwaiti dinar at 0.30540 The USDKWD opened at 0.30540 yesterday morning.