The damage limitation that ensued after Janet Yellen’s initial view expressed during the press conference that interest rates could go up six months after the Fed stopped tapering its bond buying program saw sizeable uncertainty in markets.
It’s not just investors and traders that are keen to listen in to the view of the Fed, but both developed and emerging market central banks will be extremely interested in what the Fed has to say. Certainly yesterday’s US May CPI print adds some extra spice to the meeting, with headline inflation (at 2.1%) recording the largest annualised increase in 19 months. The three-month annualised rate is now 2.8%, which is the most since 2009. Just to keep the stats going we have also seen three months of core CPI above +0.2% (month -on-month), which is the first time we’ve seen three consecutive months of gains of 20 basis points or more since mid-2011.
Perhaps then it seems fitting that Janet Yellen and the Fed will amend its inflation forecasts a touch higher for this fiscal year. In fitting with the IMF’s downgrade to its US growth forecasts to 2%, we should see the Fed lower its GDP forecasts for 2014 and 2015, as quite clearly the US is not going to grow this year at 2.8% to 3%! We should also see the unemployment forecasts altered lowered.
The Fed is currently projecting the funds rate at 1% by the end of 2015 and 2.25%, which if these projections are left unchanged, would be a surprise to both the market and the IMF who seem to be leaning on the Fed to take it easy when they do decide to lift rates. The Fed funds future is currently pricing in 77 basis points of tightening (two rate hikes) from the Fed by December 2015; given the yield here has moved in range of 85bp and 55bp since the March meeting, it suggests traders have never really believed the Fed would raise to 1% by the end of next year anyhow.
Still, the moves in the US bond market are of keen interest and we are seeing the two-year treasury at the highest level since September 2013, with the ten-year having closed convincingly above the years downtrend.
Inflation expectations on the rise
Perhaps the most interesting thing to look at is US ‘breakevens’, which is the difference between the five-year US Treasury and five-year Treasury inflation protected Securities (TIPS). This effectively measures expected inflation in the US economy over the coming five years. Currently this instrument is suggesting inflation should average 2.03% over the coming five years and the chart has clearly broken out to the upside. This has to be bad for bonds, good for the USD and any stocks that benefit from a stronger USD.
We haven’t really seen anything in the way of concern either from clients ahead of this meeting, with Asian markets on the whole fairly subdued. Certainly anyone looking for Janet Yellen to follow the aggressive lead from Mark Carney last Friday isn’t expressing that view today, with USD/JPY pushing up modestly and USD/CHF unable to re-claim the 90 handle.
AUD/USD is eyeing the 20-day moving average at 0.9313 is earnest and I feel this is the key level for traders today, however the pair isn’t really moving to aggressively and is trading in a 16 point range today. A break of 0.9313 should see the pair gravitate to key support at 0.9191 - which is the lower Bollinger band, 200-day moving average and range of lows through May.
China property showing further signs of concern
China has been a source of concern today, although you would never have guessed given the solid gains seen in Australian mining stocks today. Rebar and iron ore futures traded on the Dalian exchange have seen modest upside, as has CME copper, despite property prices increasing in 15 of 70 Chinese districts, the lowest amount of gains since May 2012. Prices in Shanghai actually fell 0.3% on the month, which is the first decrease here in two years. The China CSI 300 index is flat on the day and the general lack of concern from domestic traders seems to be enough to keep Asia from rolling over.
US futures are basically unchanged since the close of the market; however we still expect modest gains to be seen in European markets. It’s feasible we see flat trade in European equities given the FOMC meeting and press conference (shortly after) will occur when both the equity and fixed income markets are closed. The minutes from the recent BoE meeting will be in focus, however and the market feels there is a possibility that we could see at least one member dissent and vote for rate hikes. I feel this could be slightly premature and re-iterate a preference to sell rebounds in EUR/GBP toward 0.8030 on any disappointment here.
In the emerging market space traders are keen to see developments in Argentina. Certainty the credit-default swap (CDS) market has surged and is nearing the January highs. Yesterday’s speech by the economy minister to congress that the government plans to swap exchange bonds into Argentine law seems significant. Many feel this puts them on a path for default and we should see this in today’s session, with further selling of Argentine bonds, while the CDS premium should continue to spike. The question then is will this have any implications on confidence in the region, however it seems that the prospect of a CDS event here is rising.