Pre-match nerves

Posted on December 2nd, 2015

The market is displaying some pre-match nerves as it approaches the Yellen speeches that begin today in Washington and the ECB meeting on Thursday.  The policy divergence expected between the Fed and ECB is coming just as their economic data is converging more significantly, questioning the case for the Fed to hike and the ECB to cut.  Nevertheless, we still favour going with the pre-match favourites and expect EUR to fall broadly and the USD to grind out further gains. Mixed US reports may slow the pace of hikes and dampen strength in the USD, but there are few alternatives as many emerging economies continue to struggle.  JPY may also be forced up in the near term against the EUR and some EM and commodity currencies.


New York Fed Economists question the need to hike

The latest round of economic reports should be causing some concern among Fed members that it is premature to raise rates.  And this would probably be the conclusion from a group of New York Federal Reserve Economists posting their model forecasts on the Liberty Street Economics Blog.  They have downgraded slightly forecasts for growth over the next few years and see only a very gradual rise in inflation that remains below 2% over that period.  They also lowered the “equilibrium” interest rates from their previous model update in April to be only a little above the current near zero level, suggesting policy is currently not accommodative.  The downward revisions relate mainly to wider credit spreads over the last six months, tightening financial conditions.

These are by no means the official forecasts for the Federal Reserve and come from a theoretical perspective that might ignore psychological and financial stability issues of leaving rates near zero for a prolonged period.  The forecasts are subject to very wide uncertainty and Fed members may weigh differently the various nuances in the state of the economy.

Furthermore, the Fed would risk a further significant hit to its credibility if it were to not raise rates on 16 December.  As Vice Chair Fischer alluded to in recent weeks most central banks and governments around the world are prepared for a rate hike and would like to see one delivered to shift the focus away from rates lift-off.

Nevertheless, the data has not been clearly supporting the case for a hike, much appears to hinge on the strength of the labour market, and it will be very interesting to hear how Chair Yellen characterizes the state of the economy and the case for a rate rise in December and beyond.

An emphasis on gradual

Fed dove Evans said he had reservations about hiking later this month, and argued that regardless of the decision, the Fed should use the December policy statement to emphasize a gradual and data dependent path for rates,  He said he expected the rate to be still below 1.0% at the end of 2016.

Such considerations might tend to dampen strength in the USD over the year ahead, but the US rates market has cash rates barely above 0.75% at the end of 2016, and is thus not fully factoring in two further hikes next year (and one this year), and not fully factoring in a second hike (after one this year) until late in Q3 2016.  As such, the market is already on board a gradual policy tightening schedule.

Mixed to weaker US data

The weaker tone in US data include a drop in the ISM manufacturing index into contraction territory in November.  Retail sales have also lost momentum in the last few months and some retailers have downgraded their outlook for the current quarter in recent earnings reports.  Consumer confidence is solid, but off highs earlier in the year.  The housing market is solid, but also appears to have lost some momentum, and core inflation readings remain subdued.

Core capital goods orders were higher than expected and stronger in recent months to October, firmer than the first half of the year, but still well down from the peak a year ago.

Employment data have remained strong, with unemployment claims stable around record lows.  The previous employment report for October was significantly stronger than expected, with a solid uptick in annual wage growth, and helped put a rate hike on 16 Dec firmly in the picture.  The data later this week is the most crucial data point ahead of the 16 Dec FOMC decision.

Few Alternatives

The fact that the USD has continued to grind firmer in recent weeks even as the US data has been mixed and the Fed appears keen to keep expectations of further hikes gradual is more a reflection of the lack of confidence in alternative currencies.  We are not seeing a broad and consistent pick up in emerging market currencies that stand to benefit from further policy easing from the ECB, and a long period of relatively low US rates.

In Asia this reflects still tepid growth indicators as witnessed by the PMI data released yesterday and a weaker trend in the CNY as it faces a weaker growth outlook and capital outflow.  On the other hand, the recent improvement in the AUD and NZD, despite weaker commodity price indictors has probably been aided to some extent by easier global monetary policy trends.

The EUR is modestly firmer in the last day, and one could see reason for it to firm as its PMI manufacturing index is now in a rising trend, albeit still modest, and above that in the USA.  It is also seeing an ongoing fall in unemployment, albeit still well above neutral levels.  And its core inflation rate has been on a rising trend recently.

However, as we approach the ECB meeting on Thursday, Eurozone interest rates and yields at the front of the curve continue to creep lower.  As discussed in recent reports, the odds still favour a bigger set of policy easing measures than factored into the Euro rates market.


Economic news

  • Australian GDP rose 0.9%q/q in Q3, above 0.8% expected. It rose 2.5% from a year earlier, also above 2.4% expected. Household consumption rose a trend like 0.7%q/q and 2.9%y/y.  Investment plunged led by the mining investment down-turn, while net exports surged rebounding from a weak result in Q2.  The two essentially offsetting each other, consistent with the narrative of an economy transitioning through the investment to production phase of the mining boom.
  • An area of concern remains the slide in terms of trade that is dragging heavily on national income mainly through company profits in the mining sector, but feeding through to subdued wage growth and a weaker government budget. Terms of trade fell 2.4%, down 10.5%y/y. Real net national disposable income, a measure of national income adjusted for the terms of trade and some other factors fell in trend terms by 1.2%y/y, implying something of an income recession.
  • Australia: RBA Commodity price index fell 22.0%y/y in AUD terms in Nov to a low level since Jan-2006, pointing to further declines in Australia’s terms of trade
  • New Zealand: Global Dairy Trade index rose 3.6% in the biweekly auction, the first rise after falling for the previous three auctions by a total of 17.3%.
  • USA: ISM manufacturing index fell from 50.1 to 48.6 in Nov, well below 50.5 expected. The index has fallen significantly over the last year from a peak in Q3 of 2014 near 58 to contraction territory for the first time since Nov-2012, and a low since 2009.  The weaker outcome has been affected by contraction in the energy sector and a stronger dollar.
  • USA: Markit PMI manufacturing was 52.8 in Nov, revised up from 52.6, down from 54.1 in Oct, at a low since Oct-2013. The data is not as weak as the ISM report, but both have been weakening over the last year.
  • USA: construction spending rose0%m/m in Oct, stronger than 0.6%m/m expected, up from 0.6%m/m in Sep. the acceleration was driven by non-residential, and showed broad-based strength a sign that this sector is still contributing solidly to growth and employment
  • USA: auto sales were unchanged from the previous month, holding at around a record rate, although domestic sales dipped for a second month, albeit from around decade highs.
  • Eurozone: unemployment fell from 10.8% to 10.7% in October, continuing a steady fall from a high of 12.1% in 2013, to a low since 2011, still some ways to approach more normal levels that are probably below 9%
  • Eurozone: PMI Manufacturing was unrevised at 52.8 in Nov, firmer in recent months to a high since April 2014.
  • UK: PMI manufacturing was 52.7 in Nov, below 53.6 expected, down from 55.2 in Oct.  This fall reverses most of the sudden jump in this index from 51.7 in Sep.
  • Canada: GDP rose an annualized 2.3%q/q in Q3 as expected, and was revised up from -0.5% to -0.3% in Q2. However the monthly GDP data for September fell 0.5%m/m, weaker than flat expected.
  • Canada: PMI manufacturing index was 48.6 in Nov, up from 48.0 in Oct, reversing the fall in Sep, but the weakest few months in the data available since 2013. The data appeared to undermine the CAD vs AUD and NZD


In the News

  • Japan’s Government Pension Investment Fund (GPIF) has started to hedge investments in the EUR, according to “people familiar with the matter” according to a WSJ article.( Japan Pension Fund Hedges Against Currency Moves –
  • The BoE expects to impose a charge of 1 per cent of risk-weighted assets, perhaps in 0.25 per cent increments, starting next March. The aim is to help damp excessive loan risks almost before they occur. The Bank of England’s new old buffer –
  • FT reports: Although the central bank will establish a new “countercyclical capital buffer”, Mark Carney, bank governor, was clear this would initially be a relabelling of existing capital requirements rather than a new demand. He added that banks were close to meeting their long-term needs for capital. Bank of England draws line under bank-bashing –


What they said

Chicago Fed President Evans (dove)

  • “Should we raise rates or not? I admit to some nervousness about our upcoming decision. Before raising rates, I would prefer to have more confidence than I do today that inflation is indeed beginning to head higher,”
  • “Regardless of the exact date for lift-off, I think it could well be appropriate for the funds rate to still be under 1 percent at the end of 2016.”
  • Answering questions after the remarks, Evans said the Fed should use the December meeting to spell out the gradual pace of rate hikes.
  • “I think the economy is strong enough so that very gradual increases could still be quite consistent with continued strong economic growth and rising inflation,”
  • (Fed’s Evans Says December FOMC Rate Decision Makes Him Nervous –


New York Fed Economists (Marco Del Negro, Marc Giannoni, Erica Moszkowski, Sara Shahanaghi, and Micah Smith)

  • In the Liberty Street Economics Blog, a group of New York Fed Economists updated their Dynamic Stochastic General Equilibrium (DSGE) model of the economy, and found results that suggest it may be premature to raise interest rates in the USA (Though they did not draw this conclusion).
  • “The model projects that the economy will grow 2.1 percent in 2015 (Q4/Q4), 1.8 percent in 2016, and 2.1 percent in 2017. The modest downward revision in our 2016 and 2017 GDP growth forecasts is mainly attributable to increases in credit spreads registered in the last several months, which set back the improvement in economic and financial conditions.”
  • The authors estimate that the GDP output gap is still negative by around 2% (slack in the economy) and will remain little changed over the two to three year forecast horizon. “As a consequence, inflation projections are weak, with core PCE inflation expected to remain below 1.5 percent until the end of 2017. The model forecasts slightly above average real wage growth over the next few years, but such increases in future real wages and marginal costs are not suggesting strong incoming inflationary pressures. They are instead necessary for the convergence of inflation toward the FOMC long-run objective. In the absence of accelerating wages, inflation projections would be even weaker.”
  • The authors also estimate the natural or equilibrium rate of interest, and suggest that it has fallen since early in the year to be not much above zero. They said, “The natural rate is currently close to the actual rate, suggesting that policy is not particularly accommodative. Looking ahead, the natural rate is projected to increase at a slow pace, as the headwinds that brought down the natural rate during the crisis abate.”
  • The paper highlights the wide uncertainty around their forecasts with probability bands; a factor in any economic forecast. This uncertainty has been used by many in the past to argue that when you are near the lower bound for interest rates and have limited flexibility to ease policy if conditions deteriorate, then you should err on the side of being more accommodative, hold rates lower for longer. (The authors did not draw any inference for policy).
  • (The FRBNY DSGE Model Forecast—November 2015 –


On the Radar

  • USA – ADP Employment, Fed Beige Book
  • USA – Fed’s Yellen speaks to the Economic Club of Washington
  • UK- PMI construction
  • Eurozone – CPI first estimate
  • Canada – BoC rate decision


This week and beyond


  • 3 Dec – Fed’s Yellen annual Congressional testimony
  • 3 Dec – ISM non-manufacturing, Markit services PMI final
  • 4 Dec – payrolls
  • 16 Dec – FOMC


  • 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


  • 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


  • 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


  • 3 Dec – PMI services
  • 4 Dec – Labour cash earnings
  • 8 Dec – Q3 GDP final estimate
  • 14 Dec – Tankan
  • 18 Dec – BoJ

New Zealand

  • 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


  • 3 Dec – PMI services final and retail sales
  • 3 Dec – ECB meeting
  • 4 Dec – PMI retailing, German factory orders
  • 8 Dec- GDP Q3 revision


  • 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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