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Week Ahead: Monday 4th April – Friday 8th April

   

Economic Outlook  

Federal Reserve Chairman Janet Yellen’s speech last week should have settled some confusion amongst investors. The muddle stemmed from last month’s FOMC rate decision, statement and summary of economic conditions which were considerably more dovish than they had been in December. No problem there – market participants had already concluded that the Fed was far too hawkish when, at the end of last year, it not only hiked rates for the first time since June 2006 but also predicted rate hikes of 100 basis points for 2016. Investors expressed their concerns by dumping risk assets and only began to buy them back in mid-February after dovish testimony from Mrs Yellen in Washington, together with a bullish intervention from JP Morgan head Jamie Dimon calmed some frayed nerves. Then at the Fed’s March meeting, in the FOMC’s summary of economic conditions, the central bank halved the predicted rate hikes for the rest of this year from 100 to 50 basis points – inferring two 0.25% rate rises between now and the end of December.

But within days of this meeting five regional Federal Reserve presidents came out with unambiguously hawkish comments, with three actually naming the FOMC’s April meeting as an opportunity to tighten monetary policy further. They cited resilience in the US economy, momentum in the data, solid US economic fundamentals and the possibility of an overshoot for the Fed’s inflation target. Who could say they didn’t have a point? After all, Mrs Yellen was asked at her press conference a week or so earlier why the Fed was ignoring the strong employment data and sudden pick-up in inflation. Her response wasn’t helpful.

Anyway, last week Janet Yellen slapped down her colleagues with an unambiguously dovish speech. It is now clear that the Federal Reserve is looking well beyond the borders of the US when it comes to fulfilling its dual mandate of price stability and maximum employment. It no longer matters that the Unemployment Rate (despite an uptick to 5.0% from 4.9% on Friday) is hovering around an eight-year low or that inflation is well on the way to hitting the Fed’s 2% target (it has already surpassed this by some measures). When it comes to setting monetary policy the central bank is no longer truly “data dependent” as it previously insisted it was. This is because Mrs Yellen is now telling us that while the US is doing fine, there are just too many outside factors which could throw the economy off course at any moment. These factors include global economic conditions (China) and the price of oil. The Fed must be terrified of another China-inspired market melt-down which could easily be triggered if China devalues the yuan again. At the same time, there is a ton of leveraged debt tied to the oil price that will come badly unstuck if crude doesn’t head back towards $50 or $60 dollars over the next six months or so, or even worse, heads back towards $20.

Of course, the best way to support the oil price and persuade China not to devalue (because thanks to the USDCNY peg it won’t need to) is to manage a decline in the US dollar. This would also help emerging market economies with large dollar-denominated debts and US multinationals whose overseas sales and balance sheets get knocked by a strong dollar. But the dollar won’t go down if all the talk is of the Fed tightening monetary policy while the ECB, BOJ and PBOC are still piling on monetary stimulus. So from this perspective it makes sense for Mrs Yellen to suggest that policy is on hold for now, and a 2% (or perhaps even a 3%) inflation rate won’t change that. 

This week’s major economic releases include:

Monday - CNY Bank Holiday; GBP Construction PMI; EUR Spanish Unemployment Change, Sentix Investor Confidence, Unemployment Rate, PPI; US Factory Orders

Tuesday - AUD  Cash Rate,  RBA Rate Statement,  Trade Balance; EUR German Factory Orders, Spanish Services PMI, Italian Services PMI, French Final Services PMI, German Final Services PMI, Euro zone Final Services PMI, Euro zone Retail Sales; UK Services PMI, FPC Meeting Minutes; CAD Trade Balance; USD Trade Balance, ISM Non-Manufacturing PMI, JOLTS Job Openings

Wednesday - CNY Caixin Services PMI; JPY Leading Indicators; EUR German Industrial Production, Euro zone Retail PMI; USD Crude Oil Inventories, FOMC Member Mester Speaks, FOMC Meeting Minutes

Thursday - CHF Foreign Currency Reserves; EUR ECB President Draghi Speaks, ECB Monetary Policy Meeting Accounts; USD Unemployment Claims, Fed Chair Yellen Speaks

Friday - JPY Current Account, Consumer Confidence, Economy Watchers Sentiment; CHF Unemployment Rate; EUR German Trade Balance, French Gov Budget Balance, French Industrial Production; GBP Manufacturing Production, Goods Trade Balance, Industrial Production; CAD Unemployment Rate; USD Wholesale Inventories

 
Equities Outlook

I want to focus here on the market reaction to Friday’s US employment data. I was surprised by the violent market reaction to the numbers. I thought that after Janet Yellen’s speech last week we knew everything we needed to know about the outlook for US monetary policy over the next six months. Mrs Yellen made it clear that the Fed would not be hiking rates this month or even in June. This was despite the fact that the Unemployment Rate was at an eight year low (no longer quite true after Friday’s report) and that inflation was on the rise. In essence, Mrs Yellen was claiming ownership of a whopping “get out of jail free” card by saying that the global economic situation could upend all the best laid plans of the central bank at any moment. She also cited her concerns about the low oil price and even suggested that the Fed could, under certain circumstances, provide further stimulus in the form of quantitative easing. This was a very dovish speech. 

So I thought investors would take the employment data in their stride – especially a payroll number which was only above the consensus expectation by 9,000 jobs. The Unemployment Rate ticked up to 5.0% from 4.9%. But this was broadly neutral as the rise was a result of previously disillusioned workers returning to the jobs market. But it was the increase in Average Hourly Earnings which seems to have galvanised traders and their algo-driven black boxes. Earnings rose 0.3% month-on-month, more than the +0.2% rate expected. As far as traders are concerned this is inflationary (quite correct as higher wages should feed straight through to consumption). But I thought that an uptick here would be positive for risk assets as Janet Yellen made it clear that the Fed has no intention of tightening monetary policy over the next few months in response. In fact, the way I read her speech is that the Fed’s 2% inflation target isn’t really an issue anymore.

Anyway, that’s not how the markets initially interpreted the data. The dollar rose while oil, equities, gold and silver took a pounding. The Fed is getting the inflation it so badly wished for, but now investors expect the central bank to step in and raise rates to curb it. Later in the day US stock indices reversed earlier losses. But this was despite steep falls in crude oil. It’s all very confusing. Perhaps the fog will clear this week. 


 
 
Commodity/ FX Outlook


Oil

There can be little doubt that trends in the oil price are a big influence on global equity markets. In the current situation weakness in crude translates directly into a negative move on the major stock indices – particularly the Dow Jones Industrial Average and the S&P500. In other times this would be counter-intuitive. After all, if oil prices fall corporations and consumers make savings in terms of lower production costs, cheaper transport and so on. But that isn’t the situation now and it is worth reading what Janet Yellen said in her speech last week:

 “For the United States, low oil prices, on net, likely will boost spending and economic activity over the next few years because we are still a major oil importer. But the apparent negative reaction of financial markets to recent declines in oil prices may in part reflect market concern that the price of oil was nearing a financial tipping point for some countries and energy firms. In the case of countries reliant on oil exports, the result might be a sharp cutback in government spending; for energy-related firms, it could entail significant financial strains and increased layoffs. In the event oil prices were to fall again, either development could have adverse spill over effects to the rest of the global economy.”

I wrote above how the US Federal Reserve will try to support the oil price by keeping a lid on the dollar. But this won’t be enough on its own to drive crude back up to $50 or $60 per barrel. The oil price has been under pressure for the last couple of weeks now. Rallies are getting sold rather than sell-offs being bought. The turnaround in WTI and Brent which followed talk of a possible agreement between OPEC and non-OPEC producers to freeze output at January’s levels seems to have run its course. On Friday crude fell after Saudi Deputy Crown Prince Mohammed bin Salman told Bloomberg that Saudi Arabia will freeze its oil output only if Iran and other major producers do so. It fell further after the release of a strong US Non-Farm Payroll number and as Average Hourly Earnings rose more than expected. The latter is an indication that inflation is picking up so the knee-jerk reaction was to buy the dollar and sell dollar-denominated commodities.


Gold/ Silver

Gold and silver both had a solid start to March, building on their gains from earlier in the year. Just a few weeks ago silver hit its highest level since the end of October last year. Meanwhile gold hit its highest intra-day level since February 2015. Both metals have pulled back since then however. Partly this has been down to the US dollar which had a brief bounce in mid-March. But also, there has been consolidation and profit-taking which crept in following the strong performance of both metals since mid-December.

It seemed perfectly reasonable to expect gold and silver to build on their first quarter gains. After all US Fed Chairman Janet Yellen made it clear last week that a rate hike is off the table for the foreseeable future. But both metals slumped following the release of US employment data on Friday. Payrolls came in above the consensus market expectation but the unemployment rate ticked up slightly from an 8-year low. Nevertheless, this was viewed as market-positive as it indicated that previously discouraged jobseekers were now actively looking for work. Finally, average earnings rose which indicates increased inflationary pressures. Investors decided therefore to ignore Mrs Yellen’s comments from earlier in the week and instead speculated that the Fed would soon raise rates again. 


Forex

The US dollar continued its decline for most of last week. The greenback has been staggering lower ever since the beginning of December last year. This was when ECB President Mario Draghi disappointed the markets when he announced additional monetary stimulus which fell short of expectations. This was the trigger for a turnaround in the dollar’s fortunes although its decline since then has been interrupted by a number of significant rallies. Nevertheless, it is to the credit of central bankers that they have managed to keep a lid on the dollar even as US monetary policy has tightened while that of the Euro zone, China and Japan has become more accommodative.

It is generally accepted that it is the dollar’s turn to weaken. A cheaper dollar helps to support the oil price which should give US shale oil operators (and their lenders) a lift. Secondly, it helps US exporters and multinationals as a cheaper dollar boosts revenues and earnings. Thirdly, a falling dollar helps emerging market countries who have large amounts of dollar-denominated debt. And finally, a weaker dollar helps out China too. The yuan is pegged to the dollar, so the yuan gets cheaper along with the greenback. This keeps Chinese exports competitive.

The dollar came under further selling pressure following Tuesday’s speech from Federal Reserve Chairman Janet Yellen. Mrs Yellen pushed out expectations for the central bank's next interest rate hike. There was increased speculation that the Federal Reserve would hold off from further tightening until September at the earliest. But suddenly the ground beneath this new certainty shook and crumbled. Friday’s US employment data suggested further improvement in the US economy and a pick-up in inflationary pressures through average earnings. The overall interpretation was that the slack in the US economy is being wrung out and this may force the Fed to tighten monetary policy sooner than suggested by Janet Yellen. I find it hard to believe, but that’s the market for you. 

*Prices are accurate at time of writing

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: Weekly Bulletin


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