- US dollar experienced a massive sell-off as the market was pricing in more hawkish statement and projections
- Bigger winners are commodity currencies buoyed by the rally in crude oil
- The EM complex also reacted positively to the prospect of a longer period of low US rate with EM currencies posting strong gains
- On our side, we consider that the energy prices and import are far from being the only driver of a Fed rate hike. Indeed, global economic and financial conditions could prevent the American central bank to act
- Fed may be over-optimistic of the current health of its economy
- SNB holds its policy rates unchanged - sight deposit rate -0.75% & 3 month libor -0.25% to -0.75%
As we expected the Federal Open Market Committee decided to maintain the target for the benchmark federal funds rate at 0.25% to 0.5%. However, the market was expecting Janet Yellen to release a more hawkish statement, reiterating the Fed’s confidence in the strength of the US economy. The opposite happened. According to the projections accompanying the statement, the Fed lowered its growth projection from 2.4% to 2.2% for 2016 and to 2.1% from 2.2% for 2017. On the inflation front, the PCE forecast was lowered to 1.2% from 1.6% for 2016, while the median projection for the core gauge was left unchanged at 1.6%. But more importantly, the median projection for the policy rate fell to 0.875% at the end of 2016 compared to the 1.375% forecast in December, implying only two rate hikes by the end of the year instead of four. Janet Yellen cited the risks posed by recent global economic and financial developments. As a result, the US dollar experienced a massive sell-off as the market had priced in more hawkish statement and projections. EUR/USD rose almost two figures to 1.1240 amid the publication.
***Yann Quelenn, market analyst: “In the FOMC statements, the key words were as usual oriented towards the labour market and the inflation target. Optimism abounds. Yet, continued improved job conditions have not yet provided the expected boost in inflation despite the slight pick-up in recent months. Nonetheless, it continues to run below the 2% longer-term objective. The Fed remains confident that the effect of declining energy and import prices will fade and increase upside inflation pressures. Energy prices may go up, but we think that overall weaker demand will continue to push prices down. The Fed’s inflation target of 2% seems far away. From our standpoint energy prices and imports are far from being the only driver of a Fed rate hike - global economic and financial conditions are also important factors preventing the American central bank from acting. However, the Fed clearly refuses to admit that the Chinese slowdown has exposed the underlying difficulties of the U.S. economy. Chinese exports dampened by 25% in 2015, meaning that western countries have simply bought less from the Asian economy. As a result, the U.S. manufacturing sector is suffering, putting pressure on the labour market. For the time being, it remains resilient. Unfortunately, there is no mention of these domestic difficulties in the FOMC’s statements showing that the Fed may be over-optimistic regarding the current health of its economy.”***
The biggest winners from yesterday are commodity currencies, buoyed by the rally in crude oil. The West Texas Intermediate has risen more than 7% since Wednesday morning and is now trading at $39.30 a barrel. Gold surged almost 3% as Janet Yellen spoke, while silver was up 2.90%. Overnight, iron ore was also better bid as the most liquid future contracts on the Dalian commodity exchange, rising 2.53% to 426 yuan/metric ton. Copper futures were also trading higher, up 2.15%. In Wellington, the New Zealand dollar surged 3.60% against the greenback as traders priced in fewer rate hikes by the Fed. The Kiwi erased last week’s losses and returned to its pre-RBNZ-rate-cut levels at around $0.6825. Similarly, the Aussie rallied widely to $0.7645 as it finally validated a break of the 0.7440 resistance level (high from August 11th last year). The EM complex also reacted positively to the prospect of a longer period of low US rates with EM currencies posting strong gains. The Indian rupee settled up 0.83%, the South Korean won surged 1.70%, while the Indonesian rupiah was up 1.40%.
Equity traders also reacted positively to the prospect of continued accommodative monetary policy conditions and pushed US equities higher. The S&P 500 was up 0.56%, the Nasdaq rose 0.75% and the Dow Jones surged 0.43%. In Asia, regional equity markets were trading broadly higher, with the exception of Japanese equities which edged slightly lower. Mainland Chinese shares posted strong gains with the Shanghai Composite up 1.20%, while the Shenzhen Composite surged 3.56%. European futures are pointing to a higher open.
***Peter Rosenstreich, head of market strategy: SNB ready to react but no need right now: "The SNB has clearly taken a reactive rather than a proactive stance. As we expected, the SNB held its policy rates unchanged (Sight deposit rate -0.75% & 3 month libor -0.25% to -0.75%), while not tinkering with tightening banks’ threshold exemptions on negative rates. Given the SNB’s rather depleted toolbox, tightening exemption would be its first retaliatory strike. We heard the standard CHF “significantly overvalued” and “will remain active in the FX markets” rhetoric but expected no less and markets were numb to the threat. The SNB statement indicated that the conditional inflation forecast has to be revised downwards as the decline in oil prices has contributed to weaker inflation pressures. In what we view as optimistic thinking inflation is expected to return to positive territory in the coming year. In regards to the global outlook, the SNB stated economic performance as “slightly weaker” as “manufacturing and trade remained sluggish” resulting in the fact that “global economic outlook is somewhat less favorable than in December”. The result was forecasted GDP growth of between 1% to 1.5%. Finally, slowdown in real estate prices momentum was “confirmed” as mortgages lending slowed reflecting weakness in growth fundamentals.
Unlike previous ECB actions, which forced the SNB to react, the most recent ECB easing measures are perceived to be a precursor to negative rates. EURCHF has the greatest sensitivity to interest rate differentials, alongside risk appetite. Despite Draghi’s pledge that rates could go lower, the subtle shift from using interest rates as opposed to credit easing, signals that reliance on further cuts is unlikely. The subsequent lack of CHF strength indicates that the market was satisfied, narrowing of spreads was less likely, and pressure on the SNB to act decreased. Moving forward, the SNB will remain vigilant on CHF and potential capital inflows from Europe either ECB or event inducted (i.e. Brexit, Grexit, Spanish elections etc.). Barring an event shock we anticipate the EURCHF will continue to trend higher in the near term. EURCHF resistance at 1.10229 remains the primary bullish target.
Despite SNB president Jordan’s recent comments suggesting that Swiss monetary policy strategy has limited the appeal of the CHF we suspect that the SNB actually has less control. In addition, deeper negative rates lower band to -1.25% or expansion of balance sheet of 100%+ of GDP has the potential of destabilizing risks that are hard to model. We agree with SNB governor board member Andrea Maechler’s statement that there are limits to central bank effectiveness and believe the SNB is very close to those limits. Most likely the SNB will target negative interest rate exemption as a first strike. For now it’s unlikely the SNB will have to dig into its depleted tool kit, yet given the ECB deteriorating inflation and growth outlook we suspect that additional policy measures will be needed. We remain negative on the EURCHF in light of mounting European event risks and the steady demand for long-term safe haven assets.”***
Today traders will be watching producer and import price index, SNB rate decision from Switzerland; CPI from euro zone; rate decision from the BoE; current account balance, Philadelphia Fed Business Outlook, initial jobless claims and leading index from the US; industrial production and gold and forex reserves from Russia; interest rate decision from South Africa.