December Rate Hike Probabilities:
USD 83.6% = (Still in the cards)
EUR 4.4% + (Think December 2019)
GBP 84.6% + (Done deal, probably in November)
CAD 43.8% + (NAFTA uncertainty impact)
Fed Rhetoric 25bps
The focus in markets is turning
To central bank meetings concerning
How fast they may tighten
And still fail to frighten
Investors who are quite discerning
The ECB will be debating
The pace for their recalibrating
Of purchasing bonds
As Draghi responds
To markets he feels need placating
FX markets have done little overnight, though if pressed I would say the dollar continues to perform well overall. While the euro has edged higher after mixed PMI data, both the yen and pound are weaker as I type. The thing is, given the lack of significant movement I would contend we are simply seeing positions adjusted ahead of Thursday’s ECB meeting and then the BOE’s meeting next week.
At this point, the market is certain that Draghi will announce a reduction in QE although there is debate as to exactly what form it will take. Numerous economists have estimated that there are only about €300 billion of eligible bonds left for the ECB to buy which means that the program will need to end some time next year. Either that or they will need to change their self-imposed guidelines on purchases. Draghi’s problem is that core CPI continues to run far below their target of ‘just below 2.0%’ with the most recent print at just 1.1%. So despite a clearly recovering economy, the actual ECB mandate is in no danger of being met in the near term. In fact, even the ECB’s own estimates claim the target won’t be reached until 2020! And yet reducing QE is clearly the direction in which they are heading, or in the vernacular, they will be ‘recalibrating’ QE as the last thing they want is to ‘taper’ purchases. A rough and ready way to determine the impact on the euro is to calculate the total amount of purchases they promise and compare that outcome to €200 billion. The larger their number, the more euro negative the outcome. For example, if the promise is €30 billion/month for at least six months, that would be seen as mildly hawkish and I would expect the euro to rally, while if they extend that to nine months or one year, it should be somewhat dovish. My view remains that they will be more dovish than expected and, when combined with the Fed staying the course, I still like the euro lower.
Meanwhile, the pound continues to suffer from a lack of clarity on the Brexit story with growing concerns that the mooted transition period may not materialize. British industry is clamoring for some idea of what to expect as well as a two-year period in which to make the necessary changes. But if the latest news is accurate, it seems there will be no clarity on how things will evolve for quite some time. This ought continue to be a negative for the UK economy and will prevent the BOE from doing more than the single rate hike they are seemingly determined to implement next week. If anything, I expect this hike will need to be rolled back sometime next year and the BOE’s credibility will be dented further. All in, the pound still looks too rich to me.
Finally, in Japan the BOJ has not been active in the equity market for most of this month. Remember, their ETF purchase target was ~¥500 billion per month, but they would only by when the Nikkei was lower in the morning session in order to support the market. However, the market there has risen for 16 consecutive sessions, thus eliminating the BOJ’s raison d’etre in this space. In the wake of PM Abe’s landslide reelection, foreign investors have been actively buying Japanese equities while the yen has remained under pressure. For now, there is nothing to suggest this will change, although one has to expect that the Japanese equity market will correct somewhat in the near term.
The emerging market space has been far more mixed, with both winners and losers, but in truth, only the Czech koruna has moved more than 0.25%. It seems that expectations are growing that the central bank there is increasingly likely to raise rates next week as inflation pressures build in the country on the back of a stronger economy. But away from that, there is really nothing in the space to discuss.
There is no first tier data today, with only the Richmond Fed Mfg. Index (exp 17) to be released. As the Fed is also in its quiet period ahead of next Wednesday’s meeting, the FX market will need to look elsewhere for catalysts. I would keep an eye on the ongoing strife in Spain as both the Spanish government and the Catalans prepare for a more contentious period later this week when the Spanish federal government will allegedly attempt to strip the region of its autonomy completely. Meanwhile the tax reform debate in the US could see some headlines with the ability to move markets, or perhaps President Trump will surprise us with an early Fed chair selection. However, my gut tells me that we are likely to remain in tight ranges ahead of the ECB’s press conference on Thursday morning.