What Might it Take for the Fed to Deliver a Hawkish Tapering Announcement?
Today’s Financial Markets Highlights
• The dollar is trading with a softer bias ahead of the FOMC meeting, which takes the oxygen from the today’s economic reports.
• Tapering is widely expected. If the Fed wants to ensure a hawkish signal it would drop its characterization of inflation as transitory and/or accelerate the tapering to finish before mid-2022.
• China’s Caixin services and composite PMI were a bit stronger than expected. China is experiencing a broad outbreak of the virus, spurring new social and travel restrictions.
• Norway and UK central banks meet tomorrow. Norway is likely to wait until December to move. Economists are split on the BOE outcome, while the market is pricing in a hike.
• Oil prices are lower, and the December WTI contract is testing the 20-day moving average ahead of OPEC+ meeting tomorrow (~$82). It is not clear how the US will respond if the oil producers do not accelerate an increase of supply. There is some talk of coordinated drawing of strategic reserves.
With the FOMC’s decision several hours away, the dollar is trading lower against nearly all the major currencies. The Antipodeans and Norwegian krone are leading. The euro, yen, and sterling are posting minor gains (less than 0.1%). Most of the freely liquid and accessible emerging market currencies are also firmer. The Turkish lira is a notable exception. The decline in the core inflation and a smaller than expected rise in the headline pace embolden officials for another rate cut when the central bank meets on November 18. The JP Morgan Emerging Market Currency Index is rising for the second consecutive session after falling in the previous four sessions. Equities are lower. The MSCI Asia Pacific Index fell for the fifth session in the past six. Among the large markets, Taiwan and Australia bucked the trend. The four-day advance of the Stoxx 600 in Europe is at risk, and US futures are weaker. Benchmark 10 year yields are mostly two-four basis points lower across most high-income countries today. That puts the US 10-year Treasury yield near 1.52%. Australia’s two-year yield fell almost 10 bp to 0.55%. It had peaked above 0.71% last week. The three-year yield is off nearly 30 bp in recent days. Gold continues to chop within the range set last Friday (~$1772-$1801). Ahead of the OPEC+ meeting tomorrow amid talk that the US may seek to coordinate sales for a coalition of strategic reserves and a build of US inventories reported by API weigh on oil prices. December WTI has approached the 20-day moving average (~$82), which has not closed below since late August. Base metals are higher as iron ore snapped a five-day slide during which it lost over 20%. Copper is also recovering after forging a base in the $432-$433 area. It is up around 1.5% today. If sustained, it would be the largest gain in three weeks.
China’s Caixin services unexpectedly rose to 53.8 from 53.4 in September. Recall that the manufacturing reading had improved to 50.6 from 50.0. The net effect was that the composite edged up to 51.5 from 51.4. The composite has converged with the “official” PMI, which stands at 50.8. Separately, note that China is experiencing a broad spread of the virus into a dozen provinces, and the number of new cases is the highest in a couple of months. Inter-provincial travel has been restricted, and new social protocols are being introduced. According to reports, the government advised households to stock up in necessities and ensure adequate food supplies for local authorities.
Australia’s service and composite PMI shows the recovery was not quite as strong as the preliminary data suggested. The service PMI rose to 51.8, not 52.0 from 45.5. The composite stands at 52.1 rather than 52.2. It was at 46 in September. Tomorrow Australia reports Q3 real retail sales, but it will still be picking up the weakness of the lockdown. September trade figures will also be reported. Weaker exports and stronger imports are expected to have narrowed the trade surplus by almost 20% to A$12.4 bln. Ahead of the weekend, the central bank will make its Monetary Policy Statement. The swaps market is pricing in 70 bp, down from 80 bp, of tightening over the next 12 months.
The dollar has been confined to a narrow quarter yen range through the Asian session and most of the European morning. Softer yields and equities would be expected to give the yen a bit of support. The 20-day moving average is near JPY113.65, and the greenback has not closed below it since the September FOMC meeting. In the bigger picture, we have suggested the dollar-yen rally from mid-September through mid-October puts the dollar in a new range. We suspected JPY114.50-JPY115.00 marks the upper end and JPY113.00 may be the lower end. The Australian dollar fell almost 1.4% yesterday, its largest decline since May. It reached $0.7420 yesterday, just above the $0.7410 (38.2% retracement objective of last month’s rally). It has stabilized today and has (so far) been capped near $0.7450. Resistance is seen in the $0.7460-$0.7470 area. For two weeks, the Chinese yuan has been alternating between advances and declines, and net-net little changed over the period. Yesterday, the yuan slipped (0.04%), and today it is firmer (0.06%). The PBOC has consistently set the dollar’s reference rate above model projections, and today’s fix was at CNY6.4079 compared with median expectations (Bloomberg) for CNY6.4068. The PBOC was unexpectedly generous in its open market operations, injecting CNY50 bln. As a result, the overnight repo rate fell 12 bp to 1.99%.
Norway’s central bank meets tomorrow. It was the first of the high-income countries to raise rates this year, so far, followed only by New Zealand. We overstated the case for Norway to hike rates at the meeting, but don’t be mistaken. The case for a rate hike exists, but the pattern is not to move at these “off-meetings” (without updated formal policy path guidance). Instead, officials will likely confirm their intentions to raise rates in December. The swaps market is pricing in almost three hikes next year. The dollar trended lower against the Nokkie since August 20. The downward momentum stalled in late October. Yesterday it rose above NOK8.50 for the first time since mid-October. The momentum indicators have turned up. The 200-day moving average is slightly below NOK8.55 and near NOK8.60 is the (38.2%) retracement of the down move.
The UK is emerging from the economic soft patch in the June-August period. The final service and composite PMI report today showed stronger activity than the preliminary estimates. The service PMI rose to 59.1 from 55.4 in September. The flash estimate had put it at 58.0. The composite stands at 57.8, up from the preliminary projection of 56.8 and September 54.9.
The Bank of England meets tomorrow. There does not seem to be much conviction, and the market appears divided. In the Bloomberg survey, 22 of 45 economists expect a hike that seems to have been largely discounted by the markets (15 bp). Three of the largest UK banks do not expect a hike. Some observers argue that what is the point of stopping now when it would end next month. We often think the signaling channel of QE is under-appreciated. Stopping the bond-buying now adds to the seriousness of the moment if it does not lift rates. Sterling has retreated by 2.3 cents since last week’s high to approach $1.36 yesterday in the US. The euro reached its lowest level against sterling since March 2020 in late October near GBP0.8400, and yesterday rose to above GBP0.8500 for the first time since October 12.
Poland’s central bank is expected to hike the base rate 25 bp today to 0.75%. Recall that it hiked 40 bp last month to begin the cycle. It started later than Czech and Hungary. Preliminary October CPI rose 1% on the month, accelerating the year-over-year pace to 6.8% (from 5.9% in September. It was at 5% as recently as July. The Czech central bank meets Friday and is expected to hike the repo rate 75 bp to 2.25%. After two quarter-point hikes (June and August), it hiked by 75 bp in September. Inflation (CPI) rose to 4.9% in September from 4.1% in August. It is the highest since 2008. Turkey’s CPI rose by 2.39% last month to bring the year-over-year rate to 19.89% (19.58% in September), slightly lower than expected. The core rate slipped slightly to 16.82% from 16.98%.
The euro has been confined to about a quarter of a cent range above $1.1575 so far. It stalled yesterday near $1.1615, the (50%) retracement of the pre-weekend slide from almost $1.1700 to $1.1535. It is making session highs in the European morning, but we look for a less friendly North American session. There are options for about 530 mln euros at $1.16 that expire today. A hawkish Fed (see below) could bring option expirations tomorrow at $1.1525 (~825 mln euros ) and $1.1550 (~900 mln euros) into play. Sterling tested $1.36 yesterday, the lowest level since October 13. It has hardly managed to distance itself from the lows. It found new offers near $1.3635. There is a GBP675 mln option expiring today at $1.3650. A larger one (~GBP820) is at $1.3615 also expires but has liked been neutralized.
It seems well appreciated that the Federal Reserve will announce it will begin slowing the bond purchases. Most expect a reduction of $10 bln of Treasuries and $5 bln of Agency MBS. Investors appear to be anticipating the monthly reduction of these amounts through June 2022. Even with yesterday’s upticks, the June Fed funds futures contract continues to discount a rate hike then. If the effective Fed funds rate is steady in the first half of June at eight basis points and then rises to 33 bp for the second half of the month (25 bp rate hike on June 15), the average effective rate is about 20.5 bp. The contract settled at an implied rate of 20 bp yesterday.
Since this is already in the market, the tapering announcement itself may not be hawkish. There are two steps the Fed could take if it wanted to drive home the point. First, the FOMC statement has been referring to inflation as largely “transitory.” It could simply drop this qualifier or modify it. The Chair has already acknowledged that it will likely persist longer than initially anticipated. Indeed, next week’s CPI report is expected (Bloomberg survey median) is expected to have risen by 0.5%, which, given the 0.1% increase in October 2020, means the 12-month rate will accelerate to around 5.8%.
Second, after the last press conference, Powell was asked about needing to reduce monetary stimulus while the Fed was still engaged in QE. The Bank of England said it would hike if necessary while it was still buying bonds. Powell said in that situation, the Fed would not send contradictory signals but accelerate the tapering process. Quicker tapering would be a hawkish signal, and reaction by the market would likely bring forward the first hike.
The Democratic Party lost the Virginia gubernatorial context. Biden had carried the state by 10 percentage points last year, and the preliminary results suggest a loss of suburban voters, a key part of the new Democratic coalition. New Jersey’s governor contest is very close, and the Democratic incumbent is trailing. The results play on ideas that the Democrats are likely to lose both houses of Congress in next year’s mid-term election, in which it is common for the party in the White House to lose seats. Some in the press have been critical that Xi and Putin are not attending COP-26, but their leadership was always in doubt. The election results may undermine US leadership because Biden’s commitments may not get legislative support, and executive decisions could be reversed in 2024.
Today could be the first day since October 13 that the US dollar does not trade below CAD1.2400. Still, note that the greenback remains in the CAD1.2300-CAD1.2435 range set last Wednesday when the Bank of Canada turned more hawkish. Yesterday, the US dollar closed above its 20-day moving average for the first time since late September. We suspect corrective forces could lift the exchange rate toward CAD1.2475, where the (38.2%) retracement of last month’s decline is found, and the 200-day moving average (~CAD1.2485). However, in its way stands the $920 mln option at CAD1.2450 that expires today. The greenback reached almost MXN20.92120 yesterday, a new eight-month high. Sellers emerged, and the dollar closed lower to snap a five-day advance. It is softer today but holding above yesterday’s low (~MXN20.71). Ahead of the FOMC outcome, the market may be cautious about taking the dollar below the MXN20.66-MXN20.70 area.
Bannockburn Global Forex