FED’s hawkish tone boosts dollar
NBK MONEY MARKETS REPORT
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.
Kuwaiti dinar at 0.30605 The USDKWD opened at 0.30605 yesterday morning.