Getting with the program

There was no surprise from Janet Yellen’s testimony to Congress, but it was a ‘get with the program’ wake up call to the global markets, telling them they’ve been watching the wrong events. The Greek and Chinese navel-gazing has to end.

Janet Yellen
Source: Bloomberg

The macro themes of 2015 have meant most strategists (including myself) have had to been vigilant. Indices that were overvalued, historical stats against the market and the overall complacency in equities and even currency markets – all have been at some of their highest levels in seven years over the last twelve months.

The news of the day for us in the Asian time zone was that the Greek parliament voted through the new austerity measures agreed in Brussels on Monday. With over a 2-to-1 majority it was no surprise considering Prime Minister Tsipras has looked completely resigned to his fate for the past 72 hours. The European markets do look like they’ll open up stronger today, but the big move from the announcement of the ‘Greek deal’ has really been priced in since Monday. In my view, Greece should now be a side issue.

From a market perspective, the Greek and Chinese macro clouds have knocked traders and investors back into line. This is actually a minor positive in my eyes as the level of compliancy was worrying. However, these event have caused investors and commentators alike to miss the biggest macro point of the year.

The Fed is going to lift the Feds funds rate this year for the first time since July 2006. So forget China, forget Greece – this will be the biggest macro event of 2015.

Yellen, in my view, is a master of communication – her testimony didn’t dent the US equity markets in any real shape or form overnight. The bond market was also very well behaved, considering she point-blank told the market to get with the program and plan for a scenario where rates will now rise.

Here are the key points of Yellen’s testimony to Congress:

  • ‘Economic conditions likely would make it appropriate at some point this year to raise the federal funds target rate’.
  • She admitted that ‘there is still some slack in labour markets’ and the data was only showing ‘tentative signs’ of a pick-up in wage growth.
  • However, she also pointed to the fact ‘monthly inflation readings have firmed lately’.

Market reactions that matter

  • The strength in the USD reiterates our view that one rate hike is due for 2015.
  • The strength in the past few days suggests the market was short a September lift-off. That gap is rapidly closing and she reiterated ‘the time schedule is not the concern’.
  • Dallas Fed President Richard Fisher’s comments back in March ring true to me now: ‘I would rather the FOMC raise rates early and gradually, than late and steeply.’
  • Analysts are still divided between September and December. The majority is leaning towards September but not by a significant margin.
  • The second part of that debate is how many hikes we’re likely to see in 2015. The market is pricing in 1.5 rate hikes.

Who is behind the ‘program’

Back in July 2006 the final rise in the target rate saw the Fed funds rate looking to average 5.25% (no range). The current target range is 0.00% to 0.25%, and the current daily rate is averaging 0.13%. So the Fed has eased the Fed funds rate by an average of 512 basis points in nine years.

It has also added further easy money to the world’s liquidly in the form of quantitative easing - QE1, 2 and 3 was always going to be the bigger headline grabber. However, the fact investors the world over can borrow USD for what is effectively a free rate meant US-dominated debt has been ‘freely’ (pun intended) flowing around the global since January 2009.

So what will that mean to emerging markets (EMs) that are heavily indebted with US-dominated debt? We got a glimpse of the possibilities last year when there was a mass run on the Indonesian rupiah and the Indian rupee as QE3 was unwound.

The squeeze in USD debt would be seen in the likes of Vietnam, Thailand and the Philippines in the Asian region as these are some of the biggest EMs exposed to the risk of rising US rate rises.

From an Australasian perspective, this is a risk on many fronts due to the possibility of an EM slowdown, currency run-ons, current accounts being crushed and emerging corporations seeing funding evaporate – all of which would create havoc with developing economies.

It also brings the likes of Turkey, Brazil, Russia and South Africa into focus. The crushing squeeze of rising rates and a rising USD will create EM volatility not seen for several years. This is why Yellen is getting loud in her talk about rate rises – it needs it be heard far and wide and with plenty of warning.

But clearly the Fed reigns supreme and, when it raises rates for the first time in nine years this year, there will be only one currency to watch – the USD.

Don’t forget Yellen testifies again tonight, this time to the Senate.

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