FOMC: Buy one (hike) get one free?

There are rising expectations that we could see two rate hikes in the US before the end of 2015, while market pricing suggests there may be a ‘surprise’ upmove in USD if the Fed move on rates in September.

Federal Reserve
Source: Bloomberg

The FOMC is expected to conclude its two-day meeting today, although for those of us in the Asia Pacific, we shall only hear of the policy decision and statement in the wee small hours of Thursday morning. While there may be growing consensus among Fed officials and economists alike that as many as two rate hikes may be on the cards, the market is unconvinced. It is as good as certain that we will not see any aggressive move from the Fed at the July meeting and I feel that Chairperson Yellen will continue to lay the ground for an imminent interest rate increase. We may see a modestly upbeat spin on economic prospects in the policy statement, which would underpin expectations of rate hike this year. Anything less than a hardening acknowledgement that September is the month, however, may disappoint USD bulls. Though it has to be said, we have seen some paring in the greenback in the last few sessions. The Dollar Index pulled back from 98.0 to mid-96.0. This may limit the USD retreat on disappointing sentiments.

Moreover, the market is pricing in a small chance of a rate move in September, with the CME traders expecting a 54% chance of the first hike to happen in December. Goldman Sachs also expects a 25bps increase to the Fed Fund Rates in December, with the belief that the Fed would desire the first hike after seven years of near zero interest rates to be fully anticipated by the market. Additionally, with inflation still below the Fed’s target and persistently subdued, worsened by a stronger dollar and falling commodity prices, it is difficult to see a September rate hike, unless conditions significantly improve. I think that is rather unlikely.

That said, a rate hike in September, regardless of the size, would definitely surprise the market, given that a significant portion are not positioned for the rate move. This would be positive for the USD, and we could see the dollar index finally breaking the barrier at 100.

Mission: impossible – Supporting Chinese stocks?

The over 8% fall in various Chinese equity indices on Monday prompted the round of government-speak, media furore and nervous investors. Chinese authorities denied reports of a covert pullback of support measures and pledged to continue its efforts to stabilise the markets while preventing systemic risks. The media exploded with chatter of China stock meltdown and the like. Investors continued to be nervous about the whole drop, although the near flat close in the CSI 300 and a modest gain in the China A50 brought some relief.

For the moment, it seems that the Chinese version of the Plunge Protection Team has successfully defended the local equities, to a certain extent. We may even see a stronger rebound in today’s market, at least at the close, given China’s notorious volatility. We noted good support at the 200-day moving average and this could be picked up by the Chinese investors, who may add to the buying momentum as Chinese indices approach these support lines. Moreover, investigations into Monday’s plunge may keep short-sellers under the radar (or in jail!) for the time being.

A lot of analysts, myself included, are wondering whether the stock collapse has any negative impact on the real economy. While losses from stock speculations may shrink the wealth effect of consumers, the proportion of household wealth placed in equities is still fairly modest. A huge chunk is still in bank deposits and property investments. Moreover, only 9% of households actively traded shares. But we cannot really be sure. To be fair, it is difficult to ascertain the effects until sometime later but we may get a sense of where things stand from coming economic data.  China’s consumer sentiment data, to be released early today, may provide some clues on consumer spending down the road.

A broader implication of the whole episode is the damage being done to China’s reputation in the global financial world. To be sure, we won’t see a derailment in the Chinese plans to liberalise its capital account, including the A shares market, but the manner in which China handles the equity collapse may hinder its progress.

In the shorter term, the greater concern of bringing stability to the domestic stock markets takes precedent.

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