Not only did she sound sanguine about the outlook for the US economy, she warned that leaving near-zero rates for too long runs the risk of overshooting their mandated objectives, which could see a potentially abrupt and faster tightening of rates. This would be disruptive to the financial markets.
In my previous notes, I have warned about the possibility of a quicker-than-expected pick-up in inflation, owing to base effects as well as a lowering of OPEC production quota. An accelerated inflation reading could hasten the pace of US rates increase over the course of 2016, which means the 2.5 rate hikes predicted may become on the lower side.
Interestingly, much of the markets did not react much to Yellen’s remarks. To be sure, the implied probability maintained at above 70%, and USD recovered much of its losses from the previous session. We also saw some sell-off in the US treasuries. Overall, the market reaction was fairly muted. Perhaps they prefer to wait for the incoming risk events, namely, the European Central Bank (ECB) policy meeting later today or the all-important US non-farm payrolls on Friday.
Commodities however, did have a bigger response. Gold dropped -1.5% on Wednesday, to 5.5-year lows of $1050.71. That said, and not to steal the thunder from short gold traders, the key $1050 level seemed to be a formidable support barrier. Crude oil also weakened ahead of the OPEC meeting.
According to Bloomberg, there appeared to be some conflict between the OPEC members. Iran’s Shana news agency reported that most of the OPEC members are in favour of an output cut, except for Saudi Arabia and Gulf Arab countries. Venezuela is said to be proposing a 5% reduction in the collective output at this Friday’s meeting. Brent fell -4.4%, the biggest one-day fall in six weeks, to around $42.50. Likewise, WTI dropped -4.6% to almost $40.
China soothes devaluation fears
The authorities emphasised that the country will continue a ‘managed float’ exchange rate regime to maintain the yuan stability at a reasonable and balanced level after the SDR inclusion. The State Council said in a statement on Wednesday that China welcomes the inclusion and will stay committed to improve the mechanism which would eventually allow yuan convertibility under the capital account.
There was a belief that China will turn to devaluing the CNY after successfully obtaining IMF’s approval to include the currency into its SDR basket of reserve currencies. The official statements seems to aim at allaying concerns of such a move. The unexpected yuan devaluation in early August prompted fears of a global ‘currency war’, and was blamed as one of the factors behind the subsequent global stock rout in late August.
Meanwhile, the Chinese government plans to expand its local debt swap programme to about CNY 15 trillion, from the CNY 4 trillion approved for this year. Bloomberg noted that Finance Minister Lou Jiwei told a closed-door meeting in November that the scheme is set to continue through 2017.
The programme was introduced to help address the expensive local government debt that the municipal authorities have racked up in the years past. The plan is to swap high-interest local debt into cheaper municipal bonds, and is expected to take three years to complete. Elevating the debt burden of the local governments will free up some fiscal space for them.
Looking ahead to Asia
The overnight leads are not giving a strong indication of where Asian markets will head today. Ongoing caution relating to risk events could prevail on Thursday. Eyes on China markets where IPO concerns are re-surfacing, and may impact equity markets. Singapore appears to be losing steam in its rally, failing to close above 2900 on Wednesday. The tepid outlook may restrain STI bulls today, especially when S&P 500 bounce above 2100 was short-lived.
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