Brexit and NFP forces Fed’s dovish turn

The Fed has definitively killed off any hopes for two rate hikes in 2016 with their very dovish statement and dot plot expectations.

Federal Reserve
Source: Bloomberg

The Fed will be one and done for rate hikes this year, and the main question is when this one rate hike occurs. The worrying drop in non-farm payrolls employment last month and concerns about the upcoming Brexit vote appear to have driven this dovish tone. However, Yellen herself said many other employment indicators were “flashing green” and if NFP bounces back in its early July release, then a September rate hike is still a significant possibility.

Equity markets did not take the release especially well with US markets closing down for the fifth day in a row. In the wake of the release gold saw some minor gains, as did emerging market currencies and high yield debt. The hunt for yield is likely to continue globally, which may be one of the reasons why the ASX is the only market in Asia set to open higher as it offers the highest yield of any developed market at 4.6%. Japan, China and Hong Kong markets are all set to open lower today in the wake of the Fed meeting.

One of the great beneficiaries of this situation is China. The deterioration in US data and corresponding weakness in the US dollar has given China much more time to get its house in order ahead of the US rate hiking cycle. The PBOC set the USD/CNY midpoint at 6.60 yesterday, its weakest fix since January 2011. The PBOC has weakened the currency from USD/CNH 6.20 in August to 6.60 and that 4 mao move has caused some drama (1 mao = CNY 0.10), although over the past few months it had managed a dramatic weakening of the currency without any of the vitriolic market moves we were seeing in the latter half of 2015.

China also released its May monetary and credit data overnight, which continued to show fairly steady credit expansion. While Total Social Financing (the broadest credit measure) saw its smallest increase since October 2015, New Yuan Loans continued to grow at an annual pace of 21%. The weakness in the TSF figure was driven by a major decline in banker’s acceptances and the first negative issuance of corporate bonds since July 2010. Although significant concerns have recently been flagged over TSF’s inability to capture the swelling use of new off-balance sheet credit products such as trust beneficiary rights (TBRs) and directional asset management plans (DAMPs). Given that, any concerns over the May TSF number indicating weak credit growth may be overdone, but the off-balance sheet build-up of credit and liabilities should worry investors.

In other brighter economic news, the US Empire manufacturing survey moved strongly into positive territory and US PPI ex-food and energy continues to trend higher.

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