When the Federal Reserve (Fed) changed to a hawkish tone in their October Federal Open Market Committee (FOMC) statement, we believe their intent was to shock financial markets out of their complacency about the Fed being on hold for the rest of the year. During the past week, key Fed officials, such as Fed Chair Yellen and Governors Dudley and Fischer, tried to drive that point home by clearly stating the December meeting is expected to be a “live” one. As a result, the market probability for a December rate hike has increased from 50% last week to 56% as of November 5 (see chart below). So far it is working, with most key markets reacting predictably to the prospects of an “imminent” rate hike. Similar to last week, the reaction in financial assets was mixed, with fixed income and commodity markets selling off, the U.S. dollar (USD) surging and equity markets growing stronger.
1. Bank of England – One Down, Two to Go
In the coming weeks, we have two major central bank meetings – the ECB’s meeting on December 3rd and the U.S. Federal Reserve’s (“Fed”) meeting on December 15th/16th. Last Thursday was the turn of the Bank of England, known as “Super Thursday” due to the combination of a Monetary Policy Committee (MPC) meeting, the publication of the quarterly Inflation Report and the hosting of a press conference. Recent MPC votes have been pretty consistent at 8-1 in favour of retaining the current monetary policy stance, but speculation had been growing in advance of last week’s meeting that the vote might be closer than previous meetings. There was also some speculation that Bank of England Governor Mark Carney might seek to temper the market’s dovishness about future rate hikes. As it happens, the market was somewhat surprised, but more by the MPC’s dovishness than by any bringing forward of rate hikes, as the MPC emphasised the risks from a deteriorating global outlook. UK bonds rallied, Sterling fell and markets pushed the first rate hike out into early 2017. Our take is that the Bank of England played it safe – the domestic economy is doing well, inflation will be slower to return to target than compared to August but eventually will overshoot its target by a small amount in 2 years’ time. In our opinion, if data on the domestic side remains robust (particularly labour and wage growth), then there is still room for the market to price higher rates and for the Bank of England to sound more hawkish in the coming months, especially if the Fed moves in December.
Turkish Prime Minister Erdogan’s AK Party secured a larger than expected victory in Sunday’s election. Anadolu, the state news agency, reported that AKP had secured 49.4% of the vote, with primary opposition party CHP on 25.4%. The pro-Kurdish HDP crossed the 10% threshold required to win seats. In June, AKP had lost its parliamentary majority for the first time in 13 years. Following the election, the party will hold 316 seats to CHP’s 134 and HDP’s 59. Continue reading
1.Central Banks – Talking the Talk, but now have to Walk the Walk
In the last two weeks, we have had meetings of the ECB, U.S. Federal Reserve (Fed) and the Bank of Japan (BoJ). At its October press conference, ECB President Mario Draghi surprised markets with his dovish outlook, appearing to signal that the new inflation forecasts to be published at the December meeting would pave the way for a further easing of monetary policy. Draghi noted that all policy options are being discussed and that “there are no taboo’s”, suggesting that the possibility of things like corporate bond purchases could be on the agenda. Subsequent to the ECB meeting, the Fed meeting was more hawkish than market expectation, highlighting that December’s Fed meeting remained a live option for the first U.S. rate increase in nearly 10 years. Coupled with the lack of any action from the BoJ at their meeting last Friday, and slightly stronger Euro-area inflation numbers, the pressure has probably eased on the ECB to act aggressively. However, Mario Draghi may have painted himself into a corner with his dovish press conference comments. Any back-tracking on his comments, or the announcement of a smaller package of measures than expected by markets, could lead to a higher Euro and a sell-off in bond yields, causing a tightening in monetary conditions. This is exactly what the ECB have been trying to avoid. Our best guess is that the ECB announce a package that meets market expectations, but some hawks on the ECB Central Council may well be unhappy with further easing.
The Federal Reserve Board’s statement today made clear that they want the market to see their next meeting in December as a live option in which to consider raising rates. The Fed continues to see the U.S. economy growing at a moderate but steady pace. Our view for some time now has been that the Fed should raise rates in 2015 from the extremely accommodative 0-0.25% we have had since December, 2008. The policy statement was very explicit in saying that the Federal Open Market Committee (FOMC) will consider raising rates in December.