December Rate Hike Probabilities:
USD 83.6% – (Increasingly likely)
EUR 3.3% + (Think December 2019)
GBP 91.5% + (Done deal, probably in November)
CAD 32.5% – (Ain’t gonna happen now)
Fed Rhetoric 25bps
This morning Signor Draghi tries
To find a path forward that’s wise
How much and ‘til when
Will Draghi’s wise men
Buy bonds ere the program’s demise?
Markets in general have been fairly quiet as traders across all asset classes await the ECB decision this morning. Expectations are for the ECB to reduce the amount of bonds it buys each month, to between €30 billion and €40 billion, with a promise to continue buying those bonds for at least six more months and potentially longer if deemed necessary. There is no expectation for a change in either interest rates, or even in the forward guidance regarding the potential timing of interest rate changes. In fact, expectations are that Draghi will seek to lean toward the dovish side of the spectrum to prevent the euro from rallying further. Remember, that although the euro is higher by some 12% this year, it hasn’t actually moved at all in the past three months. Draghi’s fear of a higher euro stems from the concern that it will negatively impact both Eurozone inflation and corporate earnings and the export sector of the Eurozone economy going forward. All told, I agree with the consensus here, as the ongoing lack of any true inflationary impulse in Europe will force the ECB to continue QE for longer than they may want to do so. In fact, the area in which I disagree with consensus is that of interest rate expectations, with my view that the ECB, even after they have stopped adding to their balance sheet, will not raise rates for far longer than currently expected. Net, it should be no surprise that the euro has barely moved overnight amid an extremely tight trading range.
I failed to mention the Bank of Canada meeting yesterday, but it actually resulted in a somewhat surprising outcome as Governor Poloz backed away from the more hawkish rhetoric of late and not only passed on a third consecutive rate hike, but indicated that going forward policy was likely to be somewhat less hawkish than previously assumed. The market reaction was swift with the Loonie falling 1% on the news and essentially maintaining those losses overnight. As you can see at the top of the note, the probability for a December rate hike continues to fall, and even if (when) the Fed moves in December, the BOC is likely to stay put.
The most notable G10 mover overnight was GBP, falling 0.3%, after a much weaker than expected retail sales report. In the UK, there is an organization, the Confederation of British Industry (CBI), which surveys its membership with regard to different economic variables. Their October report on Retail Sales fell to its lowest level since the financial crisis in 2009, and the pound declined immediately. Clearly, the combination of Brexit uncertainty and lack of real wage growth in the UK is having an impact. Once again I will reiterate my strong belief that the pound has much further to fall as the Brexit saga plays out. Hedgers take note.
Away from the G10, the biggest mover was, once again, ZAR, which has declined 1.7% this morning after the new FinMin, Malusi Gigaba, described a bleak outlook for the country’s fiscal picture during the next three years. Concerns of yet another credit ratings cut for the nation’s growing debt load are weighing on the currency. But away from the rand, there is precious little happening in the EMG bloc as well.
Aside from the ECB meeting, we see some more US data including Initial Claims (exp 235K); Wholesale Inventories (0.4%); and Pending Home Sales (0.5%, -4.2% Y/Y). I bring up the last because of the blowout number in New Home Sales yesterday, rising by 667K, well above the expected 554K. It seems this is a direct impact of the hurricanes, as almost 20% of these sales have not even broken ground. Generally that percentage is much lower. Yesterday also saw Durable Goods print at a higher level than anticipated, 2.2% vs. 1.0% expected, as hurricane related growth there was also evident. While I am certain the Fed will recognize that this data has been distorted by the hurricanes, it also serves a great purpose in helping them argue for their continued tightening cycle despite the lack of measured price inflation.
At this point, markets remain dependent on both central bank activities as well as the US fiscal/political story. I have not mentioned Treasuries of late but during the past two months, yields on the 10-year have climbed almost 40bps. At the same time, yields on the 2-year have climbed 30bps. Historically, as US yields climb, the dollar gathers support and I see no reason for this time to be different than any of the past situations where this has occurred. Again, I continue to disagree with the narrative and believe that the Fed will remain more hawkish than the market currently expects while the ECB remains more dovish. I still like the dollar higher over time.