USD reverses part of gains by week-end

Sterling at risk of slipping to its lowest level since April

By National Bank of Kuwait

United States

this week. In a usual 8 to one vote, the bank kept the size of its QE programme unchanged aiming at an annual expansion of JPY 80 trillion at the meeting that ended Friday. According to the BoJ, it will extend the average maturity of its government bond holdings to seven-to12 years, announced a new program for exchange-traded fund purchases and said it will boost the maximum amount it can buy of any one real-estate investment trust. The initial reaction was a knee jerk reaction spike to 123.50, which was quickly corrected as the market realized that such decision does not convey direct additional stimulus. The cross ended the week at the 121.16 level.

On the commodities side, gold dropped victim of the Fed rate rise. Although gold held steady the day of the FOMC announcement, commodities as a whole fell out of favor as investors continued to assess the rate increase.

Indeed, oversupply still hangs over the oil market with the stronger dollar pressured commodities to fresh multi year lows. Oil dominated the weakness as West Texas Intermediate crude fell below the $35 and Brent below the $38 for the first time since February 2009. Moves in precious metals also caught investors’ attention with gold closing down 1.98%, the biggest daily loss since July at $1066; holding the fiveyear lows reached briefly earlier this month.

As a direct result, investors continue to shun commodity currencies with the Canadian, Australian Dollar and the Norwegian Krona falling sharply. The Canadian dollar extended its decline to new cycle low just shy of 1.4000 against the Dollar.

During the press conference, Fed Chair Yellen said that the decision reflected their confidence in the US economy and that they saw an economy that is on the path of sustainable improvement. She highlighted that while developments abroad still pose a risk, these appeared to have lessened since last summer. Yellen also argued once again that the softness in inflation was transitory and that a delay in policy normalization would have meant policy would need to be tightened abruptly later

According to the Fed statement, the outlook for the US economic activity and the labor market are now being ‘balanced’, compared to the previous statement of ‘nearly balanced’. The focus was also on how the Fed was to determine the timing and size of future adjustments. Although the statement continued to emphasize that “the committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate” the committee emphasized the dependence on the upcoming economic data. On a different point, the Fed expects to maintain the current size of its balance sheet “until normalization of the level of the federal funds rate is well under way”

The Fed’s median forecasts for real GDP growth, unemployment and inflation were unchanged relative to the previous meetings. 2016 GDP growth was revised up to 2.4%, while the 2017 and 2018 forecasts were left unchanged at 2.2% and 2.0%. The unemployment rate is expected to decline to 4.7% in the next three years, down from the previous 4.8% forecast.

Meanwhile the core inflation rate was revised down for this year and next to 1.3% and 1.6%, it was left unchanged for 2017 and 2018, the latter being the year when the Fed expects to hit its 2% target

According to the dot plot projections, although there had been some suggestions that the 2016 median interest rates path could decline, it was kept however unchanged at 1.375% or the equivalent of four 25bps hikes. The 2017 median dot was nudged down 25bps to 2.375% while the 2018 median dot was down 12.5bps to 3.25%. The longer-term neutral rate was left unchanged at 3.5%.

Initial jobless claims fell 11k last week to 271k against expectation of 275k. in parallel, disappointment came from the December Philly Fed, measure of manufacturing activity, which fell 7.8 pts this month to -5.9 against expectations of increase of +1.0. This marks the third time in the last four months that this index has been in negative territory.

Moreover, the six-month forward index of general business conditions plunged more than 20 points to 23.0 in December from 43.4 in November, and is currently at the lowest level since November 2012.

Diminished expectations may be a function of several influences in the manufacturing sector, including a stronger U.S. dollar, weaker global demand and lackluster domestic business investment.

The Eurozone economic data surprise index remained resilient throughout Q4 and outperformed the US counterpart. The continuous low currency gave a boost for all of Europe, especially Germany.

After dropping in the first two months of the fourth quarter, the Euro stabilized in December after the ECB meeting disappointment. As the market expected a further drop in interest rate and an increase in the size and composition of the monthly purchases, the ECB didn’t see the necessity to act and deliver on all expectations.

In addition, having become the funding currency of choice in 2015, the continued deterioration in emerging and commodities markets helped the Euro remain stable in December. As we come close to the holiday’s season, traders’ reaction to the Fed December meeting is to reduce risk exposure, take positions

Currencies

EUR GBP JPY CHF

Europe & UK

off and remain on the sideline into year-end.

As their policy has proven to be successful, the ECB is likely to continue to play the same game and not tolerate any Euro movement to the upside, whether by intervening verbally or through their policy decisions.

While markets expected further interest rates cut during the December meeting, the SNB left the policy rate on hold at -0.75%, versus market for around a 25% probability of a 25bp cut. The accompanying statement and press conference were dovish, reiterating willingness to actively intervene in FX markets and cut rates further.

For the SNB, the stability of the exchange rate and avoiding renewed upside pressure on the franc remains key to the monetary policy.

As the Swiss Franc remains the G10’s lowest yielder, yearly Swiss growth remains below the 1% and the country is comfortably sitting in a deflationary environment which has become the most persistent theme in Switzerland.

Swiss economic growth is expected to remain low, with consensus at 1.2% with the country caught between this slower trade and a recovery in European domestic demand. In the last quarter of 2015, UK economic data disappointed on multiple fronts. While the UK kept printing negative data, Bank of England policymakers expressed their concerns over falling commodity prices, stating that low oil prices and subdued wage growth are keeping a lid on inflation.

In the beginning of 2016, external and political drivers will be the major catalysts for the Sterling Pound. With inflation prospects looking subdued and with Europe continually stealing growth from its major partners, the benefits from UK positive employment and cheaper commodity prices have run out leaving the BoE worried about deflation and postponing any interest rates hike further into 2016, possibly beginning of 2017.

On a more positive note, this week’s retail sales volumes were up 1.7% from the month before, beating forecasts for growth of 0.5%. On the year, sales volumes were up 5%, better than the 3% growth forecast. The amount spent was also up on the year, by 1.4%.

For now, investors are likely to shy away from the UK as concerns over Brexit risk, a tighter local fiscal policy in 2016, and a continuation of weakness in emerging markets are keeping a pessimistic view on interest rates path.

This Friday, Bank of Japan surprised markets by keeping policy unchanged at its current level of ¥80 trillion expansion. Markets initially reacted positively

Rates – Dec 20, 2015 Previous Week Levels

Open

1.0986 1.5213 121.01 0.9826

Low

1.0803 1.4865 120.35 0.9786

High

1.1060 1.5242 123.56 0.9991

Currencies

EUR GBP JPY CHF

Asia

This Week’s Expected Range

Open

1.0986 1.5213 121.01 0.9826

Low

1.0803 1.4865 120.35 0.9786

3-Month

High

1.1060 1.5242 123.56 0.9991

to the more surprising news that the BoJ is to make additional purchases of exchange traded funds on top of the current ¥3 trillion of purchases that the BoJ currently makes each year. The accompanying statement showed that the Bank’s new additional program will have an annual budget of ¥300 billion and will be initially tied to the major stock index. The BoJ also announced it will increase the maximum amount of each issue of Japanese real estate investment trust it can buy. Finally, the BoJ announced that it is extending the average remaining maturing of Japan government Bonds purchases to about 7-12 years from the beginning of next year, from 7-10 years currently.

The BoJ has started to realize the little extra benefit of increasing purchases from the current level at least in terms of political risks associated. Moreover, a weaker yen from these levels is not likely to significantly improve exports volumes at the expenses of being called a currency manipulator.

The Australian government announced the budget deficit will be reduced by an extra $2.3bn in the 20152016 fiscal year, as it trimmed forecasts for the economic outlook. According to its Mid-Year Economic and fiscal outlook, the budget deficit is expected to worsen to $37.4bn, versus the $35.1bn forecast provided in May

In different news, the RBA minutes suggested lower interest rates were supporting household spending and that a weaker exchange rate is aiding firms, they also added that a subdued inflation outlook gives further scope to ease policy further

The latest retail sales out of china show that the number rose by 11.2% on a yearly basis setting a ten-month high. Industrial production was up 6.2% also while fixed asset investment was unchanged at 10.2% on a yearly basis. These indicators suggest positive momentum ahead for the Chinese economy.

In other news, the PBoC published last week a new trade weighted exchange rate index for the Renminbi. The statement released said that the intention of this was to ‘shift how the public and the market observe the RMB exchange rate movements. The statement goes on to say that it would be more appropriate to measure the performance of the RMB against both the US Dollar and also the basket of trade weighted currencies.

The PBoC expects the new basket of currencies to be a more explicit reference in setting the value of the RMB in the future. Most importantly, they see this as a signal that China does not intend to engage in competitive devaluation.

Given the strength of the US dollar, markets have started to assume that the PBoC is trying to use the basket as a justification to further weaken the renminbi and prop up the Chinese economy

Kuwait

The USDKWD opened at 0.30365 on Sunday morning.