FED’s hawk­ish tone boosts dol­lar

NBK MONEY MAR­KETS RE­PORT

Kuwait Times - - BUSINESS -

Us­ing a hawk­ish tone, the FOMC took in­ter­est rates up by 25 bps this week and the ‘dot plot’ pro­jec­tions for 2017 showed three fur­ther rate hikes in 2017 up from the two hikes an­tic­i­pated in Septem­ber. The FOMC’s state­ment also ac­knowl­edged the strength­en­ing eco­nomic ac­tiv­ity and men­tioned that mea­sures of in­fla­tion com­pen­sa­tion have moved up con­sid­er­ably even if it re­mains low. The me­dian fore­cast for US 2017 GDP growth was re­vised up to 2.1 per­cent, from 2.0 per­cent, while the un­em­ploy­ment rate fore­cast was re­vised down by a small amount to 4.5 per­cent, from 4.6 per­cent. Over­all, the com­mu­niquÈ was per­ceived as bullish as the mar­ket re­ac­tion was a one way move tak­ing the dol­lar in­dex to new el­e­vated lev­els.

In a mat­ter of one month since the Trump’s elec­tion, we have wit­nessed US 10 year rates mov­ing ex­plo­sively from 1.7 per­cent to over 2.60 per­cent the high­est level since mid-2014, and the Dol­lar in­dex set­tling above the 103.00 level. With such a move, the dol­lar has be­come the high­est yield­ing cur­ren­cies in the ma­jor 10, just af­ter the Aus­tralian and the New Zealand dol­lar. With such ram­i­fi­ca­tions, it be­comes clear that global port­fo­lios are likely to flock into the US in search of higher yields in a global neg­a­tive rates en­vi­ron­ment. The worry that might arises from such an en­vi­ron­ment is the fact that af­ter al­most af­ter eight years of very easy mon­e­tary pol­icy, the world has amassed a great amount of debt de­nom­i­nated in cheap Dol­lar fund­ing. Now that rates are mov­ing higher, a sense of panic is hap­pen­ing as non-US bor­row­ers de­mand­ing record amounts of USD-de­nom­i­nated debt at the same time caus­ing an over­shoot in the dol­lar and a drop in all the other cur­ren­cies. For now, mar­kets are pric­ing an ex­o­dus from emerg­ing mar­kets and from any econ­omy yield­ing neg­a­tive rates.

Now that US yields have reached ex­treme lev­els in a very short pe­riod of time, mar­kets could push them even higher in or­der to find the pain thresh­old in the bond mar­ket and the dol­lar is likely to push higher as yields spread fur­ther. It is clear that if this en­vi­ron­ment per­sists in the first quar­ter of 2017, then we might cre­ate a ma­jor headache for global Cen­tral banks.

In sum­mary, the Fed­eral Re­serve raised in­ter­est rates for the first time this year from 0.50 to 0.75 per­cent. Other than the fact that the econ­omy is at full ca­pac­ity, the de­ci­sion to raise rates was also backed by higher in­fla­tion ex­pec­ta­tions. If the new ad­min­is­tra­tion de­liv­ers on its fis­cal and in­fra­struc­ture prom­ises, 2017 could be the year when in­fla­tion takes over from de­fla­tion fears.

In the news con­fer­ence fol­low­ing the rate hike de­ci­sion, Fed Chair Janet Yellen of­fered an up­beat assess­ment of the state of the US econ­omy, how­ever, warned that mon­e­tary pol­icy will be op­er­at­ing un­der a “cloud of un­cer­tainty” un­til there is more clar­ity about the eco­nomic and fis­cal poli­cies of in­com­ing Pres­i­dent Don­ald Trump. In ad­di­tion, all FOMC mem­bers rec­og­nized that there is con­sid­er­able un­cer­tainty about how eco­nomic poli­cies may change and what ef­fect they may have on the econ­omy.

Back to Europe, the Bank of Eng­land left cur­rent pol­icy mea­sures on hold al­though the in­ter­est­ing take away from the state­ment was the ac­knowl­edge­ment from the MPC that ‘the ster­ling ex­change rate had ap­pre­ci­ated and this would by it­self point to less of an over­shoot in in­fla­tion rel­a­tive to the tar­get in the medium term, though month-to-month volatil­ity was to be ex­pected as mar­ket par­tic­i­pants’ view on the UK’s fu­ture re­la­tion­ship with the EU con­tin­ues to evolve. The MPC also said that the econ­omy will soften in 2017 as con­sumer spend­ing weak­ens and the vote to leave the Euro­pean Union is likely to af­fect in­vest­ment plans. The BOE ex­pects the econ­omy to grow by 0.4 per­cent this quar­ter af­ter a 0.5 per­cent ex­pan­sion in the three months through Septem­ber.

In Ja­pan, the re­sult­ing widen­ing of USJa­pan in­ter­est rate dif­fer­en­tials has driven the USD/JPY ex­change rate sharply higher, thereby rais­ing the prospect of faster po­ten­tial in­fla­tion in Ja­pan due to up­ward pres­sure on im­ported prices. With the rise of global bonds yields fol­low­ing the sud­den shift in the US curve, the BoJ can al­lo­cate its QE op­er­a­tions on the Ja­panese gov­ern­ment Bond’s longer du­ra­tion, keep­ing bond yields near the de­sired lev­els as part of their yield curve con­trol strat­egy. This mech­a­nism should in the­ory keep yields low in Ja­pan and push in­vestors in seek­ing higher re­turns abroad, hence in­creas­ing the down­side pres­sure on the Yen.

On the cur­rency front, the US dol­lar con­tin­ued to climb this week to the high­est level in 14 years at 103.56, af­ter the FED’s meet­ing. Af­ter start­ing the week at 101.51, the dol­lar in­dex closed on Fri­day at 103.020.

The Euro con­tin­ued to slip to the low­est level since Jan­uary 2003 ver­sus the US dol­lar as the spread be­tween US and Ger­man 10year bond yields widened the most since 1990. The Euro opened on Mon­day at 1.0545 against the dol­lar and reached a low of 1.0371. The pair ended the week at 1.0447.

The USD/JPY pair started the week at 115.44 and grasped a fresh high of 118.66 on Thurs­day, af­ter the spread be­tween Ja­panese Gov­ern­ment Bonds and the US 10Year trea­suries are at their widest since 2011 when Abe­nomics be­gan. USD/JPY closed on Fri­day at 117.98. In the com­modi­ties space, gold plunged to a 10-month low of 1,122.00 on Wed­nes­day as in­vestors tend to hold less non-yield­ing as­sets when in­ter­est rates rise. The metal opened the week at 1,159.000 and closed the week at 1,133.93.

Mixed US data

Re­tail sales in the US bar­ley rose in Novem­ber, in­di­cat­ing a pause in spend­ing af­ter ro­bust gains in the pre­vi­ous two months. The weak­ness stemmed mostly from the big­gest drop in auto sales in eight months as they ac­count for about 20 per­cent of all re­tail spend­ing. How­ever, most re­tail­ers re­ported im­proved re­sults last month. Sales of home fur­nish­ings, gro­ceries and gaso­line led the way while restau­rants saw strong foot traf­fic. In sum­mary, re­tail sales in­creased by 0.1 per­cent and were down by 0.5 per­cent from the pre­vi­ous month.

US in­dus­trial pro­duc­tion on the other hand marked its third de­cline in the past four months in Novem­ber, due to a steep de­cline in util­ity out­put and a dip in man­u­fac­tur­ing. The fall was the largest since March, when the in­dex fell 0.9 per­cent. In de­tails, the in­dex fell 0.4 per­cent in Novem­ber, af­ter a 0.1 per­cent rise in Oc­to­ber. Util­i­ties pro­duc­tion dropped 4.4 per­cent in Novem­ber as warmer-thannor­mal tem­per­a­tures re­duced de­mand for heat­ing.

Ger­many re­mains re­silient

Ger­man eco­nomic sen­ti­ment was un­changed in De­cem­ber from the pre­vi­ous month and missed fore­casts for a slight in­crease. The lat­est sur­vey in­di­cates a sta­ble eco­nomic growth over the next six months. How­ever, the con­sid­er­able eco­nomic risks aris­ing from the tense si­t­u­a­tion in the Ital­ian bank­ing sec­tor, as well as the po­lit­i­cal risks sur­round­ing up­com­ing elec­tions in Europe may af­fect fu­ture con­fi­dence. The eco­nomic sen­ti­ment re­mained at 13.8 points in De­cem­ber against a fore­cast of 14.2.

Europe’s PMI sur­vey showed that man­u­fac­tur­ing growth in the EU helped off­set a soft­en­ing of growth in the ser­vices sec­tor. De­spite the rise of po­lit­i­cal risks and the boost to con­sumers’ real in­come growth from lower en­ergy prices have now faded away, the con­tin­u­ous drop of the cur­rency helped off­set those risks.

In de­tails, the eu­ro­zone man­u­fac­tur­ing PMI rose to 54.9 for De­cem­ber from 53.7 in Novem­ber. This was above con­sen­sus ex­pec­ta­tions of 53.9 and the high­est read­ing for 68 months. The man­u­fac­tur­ing sec­tor gained sup­port as ex­ports in­creased strongly with an im­por­tant boost from a weaker sin­gle cur­rency. In the ser­vice sec­tor, the Eu­ro­zone Ser­vices PMI fell to a two-month low of 53.1 from 53.8 in Novem­ber, while economists pre­dicted a score of 53.8.

In­fla­tion on the rise

UK em­ploy­ment fell for the first time in more than a year in the three months through Oc­to­ber, sig­nal­ing that the la­bor mar­ket may be soft­en­ing and adding to signs of eco­nomic weak­ness emerg­ing in the af­ter­math of the “Brexit” vote. Bri­tain’s em­ploy­ment level in the Au­gust-Oc­to­ber pe­riod fell by 6,000 in­di­vid­u­als or 0.1 per­cent, while the num­ber of peo­ple who are no longer seek­ing work rose by 76,000, the largest quar­terly in­crease in eco­nomic in­ac­tiv­ity since mid-2014.

The un­em­ploy­ment rate how­ever re­mained un­changed at 4.8 per­cent, the low­est level in more than a decade, de­fy­ing an­a­lysts’ ex­pec­ta­tions for a 0.1 per­cent in­crease. In con­clu­sion, a slow­ing econ­omy could weaken Bri­tain’s ne­go­ti­at­ing hand in the “Brexit” process.

On a dif­fer­ent mat­ter, UK in­fla­tion ex­panded to more than a two-year high in Novem­ber as cloth­ing prices rose the most in 6 years.

Kuwait

Kuwaiti di­nar at 0.30605 The USDKWD opened at 0.30605 yes­ter­day morn­ing.

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