December Rate Hike Probabilities:
USD 92.3% + (NFP leaves Fed on track)
EUR 2.9% + (Think December 2019)
GBP 0.2% – (Thursday’s move will be last til 2019)
CAD 23.6% = (Middle of next year)
Fed Rhetoric 25bps
Last week we heard two things of note
First that Powell, the Prez would promote
Then the payroll report,
Though the headline fell short,
Showed the Fed, higher rates, will soon vote
FX markets this morning have shown little movement from Friday’s closing levels after a more tumultuous session last week. While the market reaction to the news that Jerome Powell would be the next Fed Chair was limited, the payroll report on Friday morning had the expected impact of boosting the dollar further. Nonfarm payrolls were not quite at the level expected, although there was a significant revision higher to previous months’ data, which offset the headline print. Of more importance, it seems was the fact that the Unemployment Rate fell to 4.1%, its lowest level since December 2000, and significantly below the Fed’s own estimate of full employment, which currently sits at 4.6%. As such, it should be no surprise that the market continues to ramp up their expectations for higher US interest rates at an increasing clip. And that will continue to support the dollar going forward. So since the close of business on Thursday, ahead of the report, only two currencies have shown any gains vs. the USD: CAD and GBP.
The CAD story can be attributed to the ongoing rally in oil prices I believe, as WTI has now rallied nearly 14% in the past month and is at its highest level since February. If we continue to see oil rise, I expect that we will continue to see support for the Loonie. Rig counts in the US have been falling of late and OPEC appears set to extend its own production cuts now that oil prices are moving up. From a technical perspective, we have also seen the Brent market extend its backwardation (when spot prices are higher than future prices), which has historically been a signal of further price rises. This indication of spot shortages is relatively new and I expect will underpin oil prices as well as the petrocurrencies for a while. While we have not seen that price action in MXN or RUB yet, NOK is firmer this morning as well.
The other rally has been in the pound, and that is one that is much harder for me to rationalize. While the BOE did raise rates, as widely expected, last week, as can be seen from the table above, the market remains convinced that they will not act again anytime soon. Adding to that is the ongoing political scandal in the British government, where senior figures are being accused of rampant sexual harassment, distracting PM May from her already difficult task of dealing with Brexit. While the UK data has held its own, given the prevailing view that the BOE is now sidelined, it is hard to make a case for a higher pound. While we have seen Sterling fall sharply since the BOE announcement, my sense is that the price action today simply represents a modest rebound on the unwinding of short positions from that move. Given the combination of the ongoing growth story in the US with the concomitant expectations of further Fed rate hikes, and the belief that the BOE will be sidelined indefinitely, or at least until after the UK exits the EU, it is increasingly hard for me to make a case for the pound to do anything but fall. Selling rallies here remains the best opportunity for hedgers in my view.
But otherwise, the G10 currencies have done little of note overnight. On the EMG side, there are two major gainers, BRL and TRY, both of which have rallied more than 0.8%. The story in Brazil is of higher commodity prices helping to underpin Brazil’s export industries and by extension its currencies. Updated inflation forecasts remain under control (3.08% for 2017, 4.02% for 2018), which has reduced expectations for policy adjustments amid a period of stability. My take is that stability is a positive here. Meanwhile, the TRY story is one of central bank support in the market as a means to slow down its recent, sharp decline. After all, in the past two months, the lira has fallen nearly 14%, and that includes today 0.85% rally. The central bank is becoming concerned and is likely to become more active in the FX market there going forward. But away from those two currencies, stories in this space are sparse.
While the first week of the months tends to bring a great deal of economic data, the second week is just the opposite, with a limited slate. Here’s what to expect:
Tuesday JOLTS Job Openings 6.053M
Consumer Credit $17.5B
Thursday Initial Claims 232K
Wholesale Inventories 0.3%
Friday Michigan Sentiment 100.6
And that’s it! None of these are likely to drive market sentiment, quite frankly. And looking to the Fed shows a limited calendar there as well, with just Dudley and Quarles on the slate for today and tomorrow. One thing I didn’t mention was the news that NY Fed Prez Dudley is set to announce an early retirement today, apparently leaving ahead of schedule, which means that there will be yet another new face at the FOMC meetings going forward. My observation is that given the markets’ generic reliance on central bank activities to support asset prices and constrain volatility, it seems that having this many changes at the Fed in such a short period of time offers the opportunity for some investors to reconsider their current market stance. If money is no longer free, does it make sense to earn just 2.3% for 10-year Treasuries? How about less than 2.0% for European High Yield securities. Perhaps normalization is coming sooner to a screen near you than expected. Benign markets have been with us for almost a decade, since the financial crisis in 2008-09. They will not last forever.