Fed's fund rate is going nowhere fast

Asia started off on a slightly optimistic footing, pricing in what was generally the most market-friendly outcome we could have seen from US data and Fed meeting.

Q2 GDP came out nicely above forecast, while the ADP private sector payrolls ensured that the chance of a terrible non-farm payrolls print on Friday has been mitigated.

Anyone looking for definitive ‘tapering’ language would have been disappointed, as it was not discussed; while we would have liked to have something meatier to chew on, in hindsight nothing has really changed. Another couple of solid payrolls should see the September meeting as the forum to expand in more depth that October will see a lower rate of US treasuries being purchased. The statement itself was more dovish than expected, although to us this was aimed to a greater degree at future moves in the Fed funds rate than ‘tapering’.

The line ‘with appropriate policy accommodation, economic growth will pick up from its recent pace’ is key, and highlights that rates are going nowhere fast. The fact that the Fed funds future (maturing June 2015) is unchanged at 52 basis points shows that markets have been massaged to such a degree that they are now fully aligned with the Fed’s views on rate rises, and this is a clear positive.

What’s more, the fact we didn’t hear anything substantial with regards to the lowering of ‘thresholds’ towards rate hikes suggests this dovish change could come at the same time as an announcement of ‘tapering’ (i.e. September), with the idea to really hit home with the separating of the two events, and provide an even bigger cushion for limiting concerns of a less aggressive expansion of the balance sheet.

Certainly much of the emerging market complex will be breathing a sigh of relief that US bond yields aren’t much higher than 2.60% today, however many of the Asian markets have had issues themselves. South Korea saw inflation gain 1.4% year-on-year, while exports increased 2.6% when they reported the trade figure a touch later. Taiwan saw an increase in the pace of contraction in its PMI numbers (48.6 from 49.5).

In Australia we started the day with a terrible manufacturing PMI print, although this is known story and is one that will take some time to heal. China on the other hand has seen some relief with its official manufacturing PMI print coming above the top-end of economists’ forecasts, printing 50.3. Breaking down the sub-sectors has shown reason to be optimistic with the new orders component pushing up to 52.4 from 52.0. This was then backed up by an unchanged reading in the HSBC print (47.7) and clearly shows the divergence between how bigger businesses are seeing things and the smaller businesses (as measured in the HSBC print), which are much more heavily affected by the deleveraging and slowdown in credit.

Chinese equities found modest buyers, with the CSI 300 up 1.3%, while AUD/USD rallied around 30 pips to 0.8994 on the PMI print before traders faded the spike. The ASX 200 started off positively, trading to a high of 5092 before an article in a local newspaper (AFR) detailed that the labor government was looking to plug the holes in the budget bottom-line by imposing a levy of between 0.5% and 1% on protected deposits up to $100,000, although these figures were marked down in amended article a touch later, by the power of 10. Banks naturally took a leg down, and as always in a situation like this the buyers stand aside as the market asks what will be the impact on earnings. One suspects these charges will be passed straight onto the consumer anyhow, in a similar mantra as negative deposit rates in Europe would see European banks charge extra for borrowing. You can make a connection therefore between the proposed levy and the falls in the AUD as extra charges are the last thing consumers need.

This levy however should not be a major negative for the banks, and you can’t see offshore funds coming in and shorting in any real size. On a more political note, Mr Rudd really seems to be making a mark given he’s only been in power for 35 days; we’ve seen an extra $200 million in taxes being added a day, and that’s before this bank levy.

Europe looks set to open flat, although for second day in a row the event risk is sizeable. On the corporate front we get earnings from Procter and Gamble (US), ConocoPhillips (US), Exxon (US), Royal Dutch Shell, AstraZeneca, Lloyds, Societe Generale and Arcelor Mittal. On the data front, the manufacturing reports continue to come in from Europe and the UK, while we also get central bank meetings from the ECB and BoE. The ECB meeting will be the more interesting of the two as there clearly won’t be additional asset purchases from the BoE; the real action will probably come when the August inflation report is released.

In terms of the ECB meeting, we expect the forward guidance to be maintained given inflation is still low and most of this has been driven by energy prices. However, there is a recovery underway in Europe and this will please the central bank. Price action in EUR/USD is tough, although trading the range has been the way to go; our preference has been to be long EUR/AUD given the strong trend currently seen.

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