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Fed’s Master Class in communication, USD strengthens amid Fed move, Mexico: following in the footsteps of the Fed

***Peter Rosenstreich, Head of Market Strategy: “In what turned out to be a central banker master-class in communication the Fed increased policy rates by 25bp, to 25-50bp, for the first time in a nearly a decade. And the market’s reaction was negligible. Fed Chair Yellen was deftly able to balance hawkish “dots” accompanied with a dovish statement. The net result was that risk appetite remained firm today with most of Asia’s equity markets trading higher. In a unanimous vote the FOMC communicated their belief that the pace of rate hikes would be “gradual”, but at a steady pace, whilst keeping Fed fund rates low for an extended period of time. The statement rationalized the rate hike by highlighting the “considerable improvement in labor market conditions this year” with the position “the stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2% inflation.” The committee indicated that each meeting would be “live” and “assess realized and expected economic conditions” indicating the data dependent nature of further policy action. Currently, the projection for Fed fund rates stands around 1.4% by end-2016, which is 50bp above what the rates futures are showing. The Fed emphasized the importance of exchange rates risks indicating that policy expectations could weigh on USD bullish momentum. We are anticipating that inflation will move quicker towards the Fed’s 2% target then the market is forecasting. Our optimistic view is for the Fed to hike rates 25bp per quarter in 2016, which is more than currently priced in to the futures. Our hawkish view against sluggish market expectations (based on strong USD, low oil and imported deflationary pressure) indicates that USD will remain supportive and vulnerable to upside data surprises.”***

It’s done, the Federal Reserve has put an end to a 7-year low interest rate policy and increased the target range for the federal fund rate to 0.25% - 0.5% from 0% - 0.25%. As expected, the decision was accompanied by a dovish statement, which stressed the need for a gradual normalization of monetary policy. In hindsight we can say that the Fed did a great job of preparing the market for a rate hike as both USD crosses and treasury yields integrated the new information in a passive way. 
Nevertheless, we have to raise the fact that the central bank lowered its core inflation projection for 2016 for the second time in a row in as many meetings from 1.8% to 1.6%, while the projected measure for 2015 was also revised lower from 1.4% to 1.3%. All in all, we have the feeling that the Fed just delivered what the market has been asking for for months: a clear sign that the economy has recovered from the financial crisis. We should not forget that the Fed’s mandate is price stability, with an inflation target of 2%, and sustainable employment level; as we know none of these objectives have been reached so far. After holding ground around 1.09, EUR/USD slid to 1.0832 in the Asian session. As I write this, the euro is trading at $1.0860. The dollar index rose 0.45% to 98.75.
***Yann Quelenn, Market Analyst: Mexico: “Following the Fed’s rate decision we were also expecting the Banxico to increase rates by 25 basis points to 3.25% despite no inflation. Indeed, the Mexican Central Bank has been obliged in the past to carefully follow the monetary policy of its neighbour in order to avoid the narrowing of the gap between the two countries’ benchmark rates. Even if the current state of the Mexican economy looks healthier with GDP for the first three quarters of 2015 averaging at 2.35% year-on-year, the USDMXN has broken 17.00, down almost 14% against the greenback this year. We remain bearish on the peso. The pair should head further north as the situation in Mexico should be appraised in the context of the current US situation due to Mexico’s extreme dependency on the US economy.
The major issue is that Mexico keeps struggling to find investors to exploit its huge oil reserves. Over the past twenty years, the country has not had the ability to invest in its own infrastructures. Therefore, the country has been forced to open up its petroleum business to private and foreign investors. Unfortunately the country has been badly hit by the lingering oil commodity prices. WTI crude oil futures are trading around their 6 year-lows, below $36, against a backdrop of global oversupply.
It is true that the peso has been consistently dropping against the dollar for the past four years. The Fed rate hike will adjust up the demand for the dollar. Mexico is not only struggling with its own economy but also with the high expectations that markets have from the US.”***
In Japan, the trade balance turned negative in November on disappointing exports. The deficit reached ¥379.7b versus ¥449.7bn median forecast. In spite of a weaker yen, Japan has been struggling to stimulate its export volume against the backdrop of weak global demand and a slowing Chinese economy. USD/JPY is treading water around 122.40 but maintains its bullish bias. On the upside a resistance can be found at 123.76 (high from November 18th).
In New Zealand, latest data indicates that the economy grew 2.3%y/y (matching consensus) in the third quarter or 0.9%q/q (versus 0.8% expected). Both the Aussie and the Kiwi, whose central banks were heavily reliant on the Fed to help them to depreciate their currency, paired losses against the greenback amid the Fed’s move. NZD/USD fell more than 1%, while AUD/USD was down 0.60% to 0.7193. The Aussie is about to test the key support standing at 0.7160 (multi low), furthermore another support can be found at 0.7017 (low from early November). We remain bearish on most commodity currencies with the Aussie and the Kiwi being the most exposed.
In the equity market, the Fed’s decision was cheered by investors around the globe with Asian regional markets all trading in positive territory. In Japan, the Nikkei was up 1.59%, while in Hong Kong, the Hang Seng rose 0.74%. In Mainland China, the Shanghai and Shenzhen Composites were up 1.81% and 2.72% respectively. Finally, Australian shares jumped 1.46% and Kiwi stocks were up 0.29%. In Europe, futures are blinking green across the board with the French CAC 40 as the biggest gainer with a move of 2%.
Today traders will be watching unemployment from Sweden; interest rate decision from the Norgesbank (expected steady) and Banxico (we expect a hike); German IFO; Italian trade balance; retail sales from the UK; unemployment rate from Brazil; retail sales, unemployment rate and gold & forex reserves from Russia; current account balance, Philadelphia Business outlook index, initial jobless claims, and leading index from the US.

Thursday, 17 Dec, 2015 / 9:49

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