Market not ready for ECB or Yellen

Posted on November 27th, 2015

Markets have been reluctant to price-in firmly communicated central bank policy agendas at the ECB and Fed.  Notwithstanding expectations that both will act, there is still considerable scope for the ECB to overwhelm expectations next week.  The market is still not fully on-board even a gradual tightening cycle by the Fed, as such it will be hard for Fed Chair Yellen to forewarn the market of a probable 16 Dec rate hike next week and sound dovish enough to cap yields.  The BoE is also likely to put downward pressure on GBP if it announces macroprudential steps on Tuesday.


The ECB is likely to move decisively not incrementally

As we head into next week, potentially the most momentous for the rest of the year, the risk appears skewed to the downside for EUR and GBP and to the upside for USD.

Overall there appears to be a degree of inertia in the markets that are reluctant to fully price-in what central banks have been attempting to communicate.

The ECB policy agenda has been firmly enunciated, but the scope, form and size of QE policy steps are by their nature harder to predict with still limited history to judge them against.  In virtually all QE measures implemented globally since their inception in 2009, the market has under-estimated the amount of QE and is still wrapping its mind around the possible depth of negative rate cuts.

It may also be the case that after such a long period of near zero rates, it is harder for the market to visualize a tightening scenario by the Fed and will only believe it when it sees it.

Furthermore, investors are struggling to position for significant policy changes about the take place, having to fight against their natural tendency to reduce risk as the year-end approaches

The Euro rates market is now fully pricing in a cut in the ECB deposit rate by 10bp to -0.30%, but little more than this.  It is quite possible that the ECB opt to cut deeper on Thursday; a 10bp seem the minimal amount likely.

The ECB overwhelmed expectations in January this year when it first implemented its QE operation, following the lead of the BoJ with its QE implementation in 2013 and 2014.  It seems more likely that if it decides to expand policy easing, it will do so across several fronts in a decisive manner.

15 analysts surveyed by Bloomberg are unanimous in their expectations that the ECB deposit rate (effective floor rate) will be cut from -0.20%.  Nine are forecasting a cut to -0.30%, five are forecasting a cut to -.40% and one is forecasting a cut to -0.45%.

Bank of England Macroprudential steps to delay hikes

On Tuesday 1 Dec, the UK Bank of England will release its semi-annual Financial Stability Report and the results of bank stress tests.  The conclusions of the BoE Financial Policy Committee, informed by these reports, will also be released.

BoE Governor Carney, a member of this committee will hold a press conference.  He hinted in testimony on the Bank’s Inflation Report earlier this week that the FPC may recommend macroprudential measures designed to dampen credit growth, such as the “countercyclical buffer” requiring banks to hold more capital against their risk-weighted loan assets.  Several other BoE speeches over the last month have hinted that the measures may be deployed.  (Carney hints at temporary rise in capital requirements for banks –

Such measures may be seen as delaying or reducing the rate hikes through the coming cycle.  As discussed in recent reports, UK 2yr yields have slipped below those in the USA for the first time since 2006.  They appear in part to have been dragged down by lower rates in the Eurozone and a weaker EUR that pushes up the GBP Trade-Weighted Index much more than that for the USD.

Fed Chair Yellen to forewarn of rising rates

On Wednesday, Fed’s Yellen gives a speech and testifies before Congress on Thursday.  The Fed appears intent of raising rates on 16 December.  There is one more employment report before this date on Friday, but the labour market trends appear to fully support the case for a policy hike.  A very weak payrolls report might cause another delay, but even a weaker than expected outcome is unlikely to provide another stay of execution.

Fed Chair Yellen will emphasize that the Fed expects the coming rate hiking phase to be significantly more gradual than previous cycles and will depend on the unfolding strength or otherwise of the US economic data.  This emphasis on a slow path of rate hikes may temper the strength of the USD. However, the reality is that the market already has priced-in a very low and slow path for US rate hikes over the coming year.

It is yet to fully discount 25bp rise in the effective cash rate on 16 Dec, and only has a second hike fully priced in by September next year.

Even though Yellen will attempt to sound balanced, it will be difficult to sound dovish if she is attempting to provide a warning that rates are likely to be raised in two weeks.

In the lead up to these central bank events this week there are significant data points that could influence expectations.  Eurozone inflation data on Wednesday could play a role.  Already core inflation has risen back to 1.1%, faster than expected, it is possible that the ECB may lessen its policy easing on the back of improved outcomes recently.  However, ECB’s Draghi appears biased to drive home the advantage and err on the side of more policy easing over less.

US economic reports have been mixed lately, manufacturing surveys in particular have weakened further to modest growth at best.  The core PCE deflator reported on Wednesday was a bit lower than expected.  The ISM manufacturing report on Tuesday next week may underwhelm modest expectations and feed doubts over the Fed policy hiking agenda.  However, the jobs market appears to have remained resilient judging by unemployment claims.  As mentioned the market is not fully on board a tightening policy path.


Economic news

  • China: Industrial profits fell 4.6%y/y in October, down from -0.1%y/y in Sep, down from year-earlier levels on average since Aug-2014. On a three-month average basis, annual growth was -4.6% 3mth-yoy, a low in data available since 2011.
  • Japan: unemployment rate fell from 3.4% to 3.1% in Oct, well below 3.4% expected, a low since 1995. The jobs to applicants’ ratio was steady at 1.24, a bit weaker than 1.25 expected.  Nevertheless this is the high in the ratio since 1992.  The labour data suggests tight conditions that should keep the BoJ watching out for a rising wage trend.
  • Japan: National CPI rose from 0.0%y/y to 0.3%y/y in Oct, a bit more than 0.2% expected. The CPI less fresh food and energy, the BoJ’s newly claimed preferred underlying measure was unchanged at 1.2%y/y, at its high. However the BoJ reported a slight dip from recent highs in two other gauges of underlying inflation – trimmed mean reported at 0.6%y/y and the share of increasing items less decreasing items was 39.7%,  these were down a touch from previous levels –eyeballing the BoJ charts (Measures of Underlying Inflation –
  • Japan: Household spending fell 2.4%y/y in Oct, weaker than flat expected, down from -0.4%y/y in Sep.

Australian capital expenditure survey released on Thursday:

  • The fall in Q3 capital expenditure of 9.2%q/q was much weaker than -2.9% expected. Mining fell 10.4%q/q and 29.6%y/y.  “Other selected industries” fell 10.0%q/q, manufacturing rose by 6.9%q/q.  The fall in “other selected industries” in the quarter was the biggest negative surprise. By value they are now around the same size as mining and the sector had helped offset the decline in mining investment in the last two years. The data will weigh on GDP forecasts next week.
  • Goldman Sachs economists applying long run realization ratio adjustment to the fourth estimate for the current fiscal year ended-Jun 2016 capital expenditure was down 19.7%y/y, weaker than the third estimate of -18.8%y/y. Much of this decline is driven by the mining sector, but the data is also revealing weaker annual expectations for the other sectors as well
  • This survey does not incorporate much of the service sectors including health and education that are growing above trend, and is weaker than business surveys and recent credit growth figures that suggest that non-mining sectors are considerably stronger than this weak survey. Nevertheless, the data will keep analysts projecting potential for rate cuts in the year ahead.


In the News

China reaction to weaker metals markets

Fitch Ratings Ltd forecast for iron ore

  • “More than 145 million tonnes of new supply is set to come on stream in aggregate, in 2015 and 2016, which is more than 10% of the estimated seaborne iron ore market of around 1.3bn tonnes. In addition, the closure of high-cost iron ore mines has been slower than we previously anticipated, despite the sharp fall in iron ore prices since 2014. Global demand, led by China, has also been weaker than we previously anticipated, and is likely to remain muted through 2016. Fitch: Fortescue Metals’ Cost Cuts, Deleveraging Support ‘BB+’ Rating –

Citibank Australian Economist Paul Brennan on the housing market:

  • “If all potential pipeline construction for apartments comes into the market, it will pose a significant downside risk to price growth for the next two years.”
  • “Given this significant pipeline of work, especially for apartments, our forecast is for a gradual, rather than a rapid, decline in [building] activity over the next few years, assuming interest rates do not rise sharply.” The contribution from residential construction to GDP is forecast to halve from 0.5% this year to 0.25%.
  • Brennan noted that slowing construction activity and weaker house price growth, dampening consumer spending, and no concrete signs of recovery in non-mining business investment meant that interest rates will need to stay low for longer. “Indeed, our central case has been that the RBA could cut the cash rate again to 1.75% (currently at 2.0%).”
  • Brennan expects an under-supply of houses estimated to have peaked at 49,000 in 2013/14 will halve over two years on rising supply and slowing immigration.
  • He predicts annual price growth to slow from around 10% to zero-to-5% over the next two years as under-supply eases and foreign demand eases on tighter enforcement of regulatory restrictions.
  • House prices are cooling, not crashing – but may force RBA cut, Citi says –


On the Radar

  • Eurozone: Friday: EC business surveys
  • UK: Friday: consumer confidence, GDP Q3 revision and components

Next week and beyond


  • 30 Nov – Chicago and Milwaukee PMIs, Dallas Fed Mfg index, Pending home sales
  • 1 Dec – ISM manufacturing, Markit PMI manufacturing final, Construction spending, Vehicle sales
  • 2 Dec – ADP Employment, Fed Beige Book
  • 2 Dec – Fed’s Yellen speaks to the Economic Club of Washington
  • 3 Dec – Fed’s Yellen annual Congressional testimony
  • 3 Dec – ISM non-manufacturing, Markit services PMI final
  • 4 Dec – payrolls
  • 16 Dec – FOMC


  • 30 Nov – Credit growth, mortgage approvals, Lloyds business barometer
  • 1 Dec – PMI manufacturing,
  • 1 Dec – BoE bank stress test results, Financial Stability Report, Governor Mark Carney press conference, Financial Policy Committee recommendations
  • 2 Dec- PMI construction
  • 3 Dec- PMI services
  • 4 Dec – Car registrations
  • 7 Dec – CBI industrial trends survey
  • 8 Dec BRC retail sales monitor
  • 9 Dec – record of meeting of BoE Financial Policy Committee
  • 10 Dec – BoE policy decision
  • 15 Dec – CPI
  • 16 Dec- Employment and wages


  • 30 Nov – TD inflation, HIA new home sales, Company profits, Inventories, business indicators, Credit growth
  • 1 Dec – PMI manufacturing, CoreLogic RP Data House prices, Net exports and current account, Building approvals, RBA policy decision
  • 2 Dec – GDP Q3
  • 3 Dec – PMI services, Trade balance
  • 4 Dec – Retail Sales
  • 7 Dec – PMI Construction, ANZ Job ads
  • 8 Dec – NAB Business survey
  • 9 Dec – Westpac Consumer confidence
  • 10 Dec – Employment report
  • 15 Dec – RBA policy minutes
  • mid-Dec – MYEFO


  • 1 Dec – Govt PMI manufacturing, and non-manufacturing, Markit PMI manufacturing and services
  • 8 Dec – trade balance
  • 9 Dec – CPI
  • 12 Dec – Retail sales, IP, FAI
  • Week of 10 Dec – Credit growth and money supply
  • 18 Dec –Property prices


  • 30 Nov – BoJ Governor Kuroda speech to local business leaders in Nagoya.
  • 30 Nov – IP, Retail sales, Vehicle production, Housing starts and construction
  • 1 Dec – Capital Spending, company profits and sales, Vehicle sales
  • 3 Dec – PMI services
  • 4 Dec – Labour cash earnings
  • 8 Dec – Q3 GDP final estimate
  • 14 Dec – Tankan
  • 18 Dec – BoJ

New Zealand

  • 30 Nov – Building Permits, ANZ business survey, credit growth
  • 1 Dec – Dairy auction
  • 2 Dec – ANZ commodity price index, terms of trade
  • 3 Dec –Value of building Q3
  • 8 Dec – Manufacturing volume Q3
  • 10 Dec – RBNZ MPS and policy announcement
  • 15 Dec – Govt Half Year Economic and Fiscal Update
  • 17 Dec – GDP Q3


  • 30 Nov – German CPI and retail sales, Italian CPI
  • 1 Dec – PMI manufacturing final
  • 1 Dec – Unemployment
  • 2 Dec – CPI first estimate
  • 3 Dec – PMI services final and retail sales
  • 3 Dec – ECB meeting
  • 4 Dec – PMI retailing, German factory orders
  • 8 Dec- GDP Q3 revision


  • 30 Nov – Current account
  • 1 Dec – GDP Q3, PMI manufacturing
  • 2 Dec – BoC rate decision
  • 3 Dec- Parliament reopens after election, new PM Trudea Throne Speech
  • 4 Dec- Trade balance, productivity
  • 4 Dec – Labour data
  • 9 Dec – BoC Governor speech
  • 15 Dec – BoC Financial Systems Review
  • 18 Dec – CPI
  • OPEC 4 Dec – group meets in Vienna to discuss the production ceiling. At issue is plans by Iran to boost production by 1m barrels per day within 5 to 6  months of sanction being removed



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