No surprise ECB rates cut, markets cautious

NBK WEEKLY MONEY MARKETS REPORT

KUWAIT: After the liquidation that hit equities and currencies emerging markets on Tuesday and following a rocky Thursday when the European Central Bank left rates unchanged while Draghi drove the euro to the highest level we have seen in over a week, the week ended on a quiet tone.

The inaction of the ECB council on Thursday have caused more uncertainties coming into next month meeting with many investors were disappointed by the status quo of the Bank and the lack of a surprise drop in interest rates in Europe. Draghi refused to signal a clear commitment mentioning the council would await the new ECB staff projection for the year 2016. It seems that the ECB council is deeply divided, with Germany’s two members resisting any move that brings the ECB closer to quantitative easing.

On the other side of the world, emerging markets remain cautious and the absence of any further shocks has seen global risk appetite recover slightly after the drop of Tuesday. Indeed, we had a break in the EM world sell off as most currencies rebounded somewhat by the weekend.

In the US, the disappointing employment report fuelled investors’ expectations that the Fed would stop tapering its asset purchases program, thus sending equity markets higher on Friday’s close. Federal reserve Fisher attempted to calm markets by arguing that the job data was significantly affected by the bad weather in the US in the month of January.

On the foreign exchange side, Markets closed the week with a stronger sterling pound. Employment news out of the US pushed the dollar lower while a short squeeze pushed GBPUSD higher. After reaching a low of 1.6252 on Tuesday, the Pound ended the week at 1.6411. The euro on the other hand, behaved in a more bullish manner. After dropping to a low of 1.3477 going into the ECB meeting, the currency closed the week at 1.3634.

In the commodity complex, Gold con- tinued its attempt to climb reaching a high of $1,275 after the release of slightly lower ADP than expected and a more disappointing employment report. The change in unemployment rate to 6.6% accompanied with a lower participation rate on Friday reinforced the move causing the metal to close the week at $1,266.

Unemployment at 6.6%

The US economy added just 113,000 new jobs in January, according to figures released on Friday, fuelling fears that the recovery in the jobs market appeared to have stalled. Expectations were for the economy to add around 180,000 jobs. This is the second month of disappointing jobs news, which last month surprised investors as the number was just 74,000 jobs in December, well below the 200,000 markets had been expecting.

We should however keep in mind that nonfarm payrolls have averaged gains of +187k per month. Even if we have another weak reading in February, that average monthly gain is likely to remain above +170k.

The hurdle to a “non-taper” remains very high and would likely need to be evident in weaker monthly job reading that extend past February.

Normal balance-sheet

In a speech given in Florida, Boston Fed Eric Rosengren, dovish non-FOMC voter, said that the Fed should be “quite patient” in removing stimulus. Too much labor market slack along with very low inflation calls for highly accommodative policy. As labor markets were far from conditions that warrant raising rates, he added that the Fed’s goal was to avoid repeating Japan mistakes over deflation. He reiterated the need to see inflation rate closer to 2%, however he said that Fed tapering was possible because the economy was improving at home.

Finally yet importantly, he argued that monetary policy would not have to be as accommodative if fiscal policy were so as the Fed wanted a more normal balance sheet when that becomes

appropriate.

ECB buying time

The accompanying press conference of the European Central Bank decision on Thursday albeit was dovish, was full of uncertainties. So close to the zero bound for policy rates, and in a situation where any unconventional action would be politically sensitive, the ECB has less room for maneuver to accommodate a policy error. Rather than addressing the downside risks head-on, the ECB decided to play for time and gather more data.

The Council did not want to pre-empt the new staff forecasts. In an unanticipated move, next month, the staff will publish 2016 forecasts, nine months earlier than usual. This creates some additional ambiguity. If projected inflation by 2016 remains significantly below the ECB’s definition of price stability, then the ECB would be required to potentially accommodate further, but would also take the risk of triggering themselves a dis-anchoring in market inflation expectations.

France rejects deflation threats

Member of the governing council of the European Central Bank’s and Bank of France Governor, Christian Noyer argued it would be normal to see euro weaken given their delay behind the US recovery. On the inflation matter, he mentioned that the euro area was not facing deflationary threats: “I’m saying it as strongly as possible: the situation has nothing to do with deflation. The situation isn’t normal but it’s not alarming.” On a different subject, he argued that turbulence in emerging markets is unlikely to affect the euro-zone because transmission channels were limited. Over the French situation, he continued praising Hollande plan to lower social charges as the plan may add “several hundred thousand jobs” and one percent of GDP over two or three years.

UK awaiting inflation report

Awaiting guidance from the inflation report, the Bank of England left both rates and asset purchases on hold, and gave no clues as to what to expect from next week’s Inflation Report. On Wednesday the Bank is likely to provide an update on guidance given that the unemployment rate is closing in on the 7% threshold and is likely to go through it given the strong pace of GDP growth

On the economic data front, last week’s UK BRC shop price index showed prices falling at a faster rate -1% in January from -0.8% in December. This drop represents the fastest rate of deflation since the index began in 2006. Food inflation slowed and non-food deflation intensified as discounting became more aggressive after the holidays season. According to the CRB food price index, we can expect further falls in food price inflation in the CPI going forward too, which is important as food is worth almost a tenth of the basket.

Better days ahead

The Reserve Bank of Australia raised its growth and inflation projections higher, reflecting a weaker currency and reiterated its shift to a neutral policy stance in the release of the monetary policy statement. Over the past few months, there have been further signs that very stimulatory monetary policy is working to support economic activity,” the RBA said in its quarterly monetary policy statement in Sydney. “The board’s view is that a period of stability in the policy rate is likely.”

In summary, the Bank projected inflation to hit the 2-3% band in June before slowing down back to 2.5%. When it comes to interest rates, markets are not expecting the Bank to cut rates in the next six month; however, investors are pricing a first 25 bps rate hike by March 2015.

BoJ ready to act further

The Bank of Japan stand ready to expand monetary stimulus further to safeguard its inflation mandate, two top policy makers said Thursday, warning that the rout in emerging markets was already affecting Japanese assets by lifting the safe-haven yen and hurting equities. The main concern amongst BoJ officials they said, was that trouble elsewhere specifically in Emerging Markets could undermine all their efforts. He reinforced that BoJ won’t stop easing abruptly, allaying fears from a report a few days back highlighting that the BoJ was slowing down their quantitative easing.

Kuwait

Kuwaiti dinar at 0.28235 The USDKWD opened at 0.28235 yesterday morning.