December Rate Hike Probabilities:
USD 87.1% + (Increasingly likely)
EUR 2.7% – (Think December 2019)
GBP 90.0% + (Done deal, probably in November)
CAD 43.6% = (NAFTA uncertainty impact)
Fed Rhetoric 25bps
In London on Threadneedle Street
The BOE, monthly, does meet
The data today
Could certainly sway
Next week, a rate hike, to complete
The pound is the big winner this morning, rallying more than a penny after Q3 GDP data was released showing better than expected growth of 0.4%. While that still equates to an annual growth rate of just 1.6%, the market was looking for worse, hence the pound’s sharp reaction. Interest rate traders have taken the news as a reaffirmation that the BOE will raise rates at their meeting next week. Alas, the BOE remains caught in a tough situation. GDP growth at 1.6% is just not that impressive on a historical basis, and ordinarily would not result in a central bank considering rate hikes. But the ongoing impact of the pound’s sharp deterioration since the Brexit vote in June of last year has led to inflation running well ahead of the bank’s mandate of 2.0% (last printed at 3.0%). Thus Governor Carney and his colleagues find themselves between the proverbial rock and hard place. They need to address inflation but they don’t want to undermine a soft growth pattern. Thus my view remains that while the BOE will act next week and raise the base rate by 25bps, it will be the last rate hike for a number of years. As long as there is uncertainty due to the Brexit outcome, which should last until the UK leaves the EU in March, 2019, the BOE will not be able to consider raising rates again. All told, I see today’s rally as a gift to receivables hedgers.
On the other side of the spectrum, today’s biggest loser has been the Aussie dollar, falling nearly 1.0% after weaker than expected CPI data (1.8%, exp 2.0%) undermined any thoughts that the RBA would consider raising rates in the near future. While the base rate in Australia remains at historically low levels of 1.50%, the ongoing lack of inflationary pressures has allowed the central bank to watch from the sidelines as growth Down Under picks up. But traders continue to be more focused on interest rate policy than growth, per se, and so with policy tightening the order of the day elsewhere in the world (notably the US and Eurozone), the lack of tightening here will continue to weigh on the currency.
But away from those two currencies, there is truly not much of a story to tell in FX today. The yen continues its weakening pace, but last night’s movement was meaningless. Meanwhile, the euro has edged higher again this morning, just 10 pips though, ahead of tomorrow’s ECB announcement. The debate on exactly what the ECB is going to do with regards to tapering QE continues, but with no further clarity until tomorrow, there is no reason to consider establishing a position here. It is uniformly expected that the amount of bonds purchased each month will decline, but by how much remains unknown. Of more importance, at this stage, seems to be the wording around when interest rates might start to rise. The current guidance explains that, “We expect them [interest rates] to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases.” So any changes to that line will be closely watched by the market. Personally, I don’t believe Draghi will adjust that wording while he is explaining the changes in QE. It will be easy for him to wait until the December meeting to start adjusting those expectations, especially given just how persistently low inflation remains in the Eurozone. But until we hear from Signor Draghi, I can’t imagine the euro will show much movement.
As to the Emerging markets, it has been a rather dull session with an equal number of gainers and losers and no currency making any significant headway in either direction. The end of the Chinese Communist Party Congress resulted in President Xi consolidating his power without naming a likely successor. Arguably, this means that we will see further state control of the economy there which means that in the short run, currency activity will be closely managed. Therefore, it may well be time to reconsider my belief that the renminbi would weaken more substantially going forward. Rather, my take is that Xi will want a stable currency as part of his legacy, and given both the ability and willingness of the PBOC to essentially fix the currency, I’m guessing that is the most likely outcome going forward. For hedgers, payables ought to be hedged to earn those points while receivables are probably best left alone.
This morning brings the first real data of the week with Durable Goods (exp 1.0%, 0.5% ex-transport) and New Home Sales (554K). The thing about Durable Goods is that the series is so volatile it is difficult to draw any conclusions about the economy from any one data point. Meanwhile, the housing market continues to exhibit the behavior of a market that has peaked with all of the indicators somewhat lower than they were earlier this year. Perhaps the Fed’s actions to date have had a bigger impact than generally believed. But at the end of the day, I don’t believe either of these numbers will be sufficient to change views by Fed policymakers, or by the traders and investors who are watching them. So two surprising numbers brought two opposite reactions in the markets overnight, but for the rest of the day I don’t expect much additional movement. We will need to wait until tomorrow’s ECB statement for the next really big piece of news.