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Pops & Drops - December 12, 2016

By: Tony Valente Dec 12, 2016 1:00:00 PM


 

Pops & Drops

finviz.pngThe fireworks last week revolved around Thursday’s European Central Bank policy meeting and the euro. The euro promptly popped up to 1.0875 against the USD after the ECB announced it would keep interest rates unchanged and extend its bond buying programme beyond the March deadline to the end of December 2017, but at a reduced pace of 60 bln euros rather than 80 bln euros. The initial reaction was that the ECB had just announced the beginning of a tapering, i.e. the scaling back of monetary stimulus by reducing bond purchases.  The market consensus was for a six-month extension but without tapering.  However, upon more thorough analysis the market realized that the ECB wasn’t tapering at all – in fact it was going to buy 540 bln euros (9 months x 60) of bonds instead of the 480 bln (6 months x 80).  Once the market realized that less was more and that the ECB had reloaded its bazooka the euro promptly dropped.  ECB President Mario Draghi strenuously denied in his press conference that tapering was even discussed and he emphasized that the purchases could be extended further if needed.


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The ECB made very little changes to its GDP forecasts. It reduced 2017 estimate from 1.7% to 1.6%, kept 2018 at 1.6%, and introduced its 2019 estimate also at 1.6%.  With US trend growth near 1.8% one could argue that the ECB is already at or near trend growth and could in fact end its stimulus.  So why didn’t they - in a word, politics.  As we saw in June with Brexit and in November with the US election, the populist revolt may be just getting started and spreading to the rest of the western world.  You need not look very far since only last Sunday Italy’s no vote on Senate reform may be the first path to a rejection of the euro and EU membership.  We think that Mr. Draghi took out an insurance policy by extending his QE programme because 2017 will be a year filled with key national elections in the Netherlands, France, Germany, and possibly Italy.  If the elections don’t go according to plan then the ECB will be busy buying bonds to dampen the damage to banks and governments.

 

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On a side note, the Wall Street Journal had a rather interesting article on QE on Friday titled Hooked on QE: Hedge Funds See Dangerous Addiction.  It turns out that some prominent hedge fund managers are joining an increasingly bigger and louder chorus which says central bank bond buying programs that are pumping trillions of dollars into global markets will end badly.  Luke Ellis, chief executive of Man Group, one of the world’s biggest hedge-fund firms with $80.7 billion in assets, say that “there’s no non-messy way out of this.”  “There’s two versions” of how this ends, he added. Either central banks could move to so-called ‘helicopter money,’ where they buy debt from the government, which then spends the proceeds or gives it to the population to spend. This “for a few years looks golden then leads to hyperinflation,” he said. Or the speed at which money circulates within the economy could grind to a halt. “Then you effectively have a barter economy,” he said.  For more sober analysis, just ask any retiree who is trying to live off his saving in a low or negative interest rate world.

From one central bank meeting to another – this week’s key event will be Wednesday’s Federal Reserve policy announcement. The market and the USD have already discounted a 25bps hike in interest rates.  Thus, the market’s focus will be on the accompanying Summary of Economic Projections (dot plot) and Chair Yellen's press conference.

According to the CME's FedWatch tool, until the November 2017 meeting, the market is pricing in a 25.4% chance of no additional rate hikes, a 40.3% probability of one more rate hike, a 24.4% likelihood of two more hikes, and a 7.4% chance of the Fed raising rates three or more time. Meanwhile, the last dot plots had Fed members looking for 50 bps of tightening next year.  We bring this up because if you remember from the December 2015 dot plots, the Fed members were expecting 4 rate hikes of a quarter point – we are still waiting for the first one.  Because of this, we are looking more towards what Yellen says rather than the dot plots.

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If Yellen indicates that there will be only a single interest rate hike in 2017, the USD will likely reverse its recent gains and fall sharply. If she indicates that there will be two hikes in 2017, we may not see a big reaction and the USD could consolidate since, as mentioned above, the last dot plots only show 2 hikes for next year.  If Yellen comes off as very hawkish, insinuating at the potential for three or more rate hikes (an unlikely development in our view), the USD would soar. Of course, there could be one other outcome – no rate hike at all.  This would really throw a wrench into things and pretty much seal her fate with President-elect Trump, who has been a critic of the Fed for keeping rates too low.

Finally, we would be remiss if we didn’t mention the quiet strength of the CAD as of late. The CAD has moved up against the USD for six of the past seven trading days.  The OPEC deal along with the addition of some non-OPEC countries, led by Russia, to also cut oil production have spurred a nice recovery in the price of oil.  The Bank of Canada left rates unchanged last week and issued a firmly neutral monetary policy statement.  Having said that, the technical indicators for both the CAD and oil are getting stretched.  One more lurch higher in the CAD, before making a short term top and hitting overhead resistance, may be in the offering ahead of Wednesday’s FOMC meeting.

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Key Data Releases This Week 

      Forecast Previous
MONDAY, NOVEMBER 14
21:00 CNY Industrial Production y/y  6.1% 6.1%
TUESDAY,  NOVEMBER 15
04:30 GBP CPI y/y 1.1% 0.9%
WEDNESDAY,  NOVEMBER 16
04:30 GBP Average Earnings Index 3m/y 2.3% 2.3%
04:30 GBP Claimant Count Change 6.2K 9.8K
07:15 GBP BOE Gov Carney Speaks    
08:30 USD Core Retail Sales m/m 0.4% 0.8%
08:30 USD  PPI m/m 0.3%   0.3%
08:30 USD Retail Sales m/m 0.3% 0.8%
10:30 USD Crude Oil Inventories   -2.4M
14:00 USD Federal Funds Rate <0.75% <0.5%
14:00 USD FOMC Statement    
14:30 USD FOMC Press Conference    
19:30 AUD Employment Change 17.6K 9.8K
19:30 AUD Unemployment Rate 5.6% 5.6%
THURSDAY,  NOVEMBER 17
03:30 CHF Libor Rate -0.75%   -0.75%
03:30 CHF SNB Monetary Policy Assessment    
04:30 GBP Retail Sales m/m 0.2%  1.9%
07:00 GBP Official Bank Rate  0.25% 0.25%
07:00 GBP MPC Official Bank Rate Votes 0-0-9 0-0-9
07:00 GBP Monetary Policy Summary    
08:30 CAD Manufacturing Sales m/m 0.7% 0.3%
08:30 USD CPI m/m 0.2% 0.4%
08:30 USD Core CPI m/m 0.2% 0.1%
08:30 USD Philly Fed Manufacturing Index 9.1 7.6
08:30 USD Unemployment Claims   258k
11:15 CAD BOC Gov Poloz Speaks    
FRIDAY,  NOVEMBER 18
08:30 USD Building Permits 1.24M 1.26M

 

 

tony.png by 
TONY VALENTE
Senior FX Dealer,
Global Treasury Solutions
                 FRED.png by 
FRED MAURER
Senior FX Dealer,
Global Treasury Solutions

Topics: Trends, Analytics, key data releases, OPEC, Currency Market Trends


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