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October 29th, 2015 6:37 am | by John Jansen |

Via Marc Chandler at Brown Brothers Harriman:

Dollar Mixed in the Wake of FOMC

– The Federal Reserve gave the clearest signal to date that it is prepared to hike rates at its last meeting of the year on December 16
– The divergence theme that we emphasize has driven the US-German 2-year interest rate differentials to new cyclical highs
– Late yesterday afternoon, the RBNZ left rates steady at 2.75%
– Surveys suggest that around 40% of investors expect the BOJ to expand its asset purchases program when it meets tonight – we are less sanguine
– Brazil reports October IGP-M wholesale inflation; Mexico central bank meets and is widely expected to keep rates steady at 3%

Price action:  The dollar is mixed against the majors in the wake of the FOMC decision.  The dollar has given back some of its post-FOMC gains to the Scandies, the Swiss franc, and the euro, but has managed to build on its gains against the dollar bloc.  The euro is trading near $1.0965 after earlier testing the $1.09 area, while sterling is trading flat near $1.5265.  Dollar/yen is lower near 120.80 ahead of the BOJ meeting tonight, with the yen helped by firm IP data.  EM currencies are mostly softer.  The CEE currencies are outperforming while IDR, KRW, RUB, and MYR are underperforming.  MSCI Asia Pacific fell 0.9%, with the Nikkei up 0.2%.  China markets were higher, with the Shanghai Composite up 0.4% and the Shenzen Composite up 0.8%.  The Dow Jones Euro Stoxx 600 is down 0.3% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 1 bp near 2.09%, while European bond markets are mostly softer.  Commodity prices are mixed, with oil and copper down over 1%.

  • The Federal Reserve gave the clearest signal to date that it is prepared to hike rates at its last meeting of the year on December 16.  If Draghi was more dovish than expected, the FOMC statement was more hawkish than anticipated.  The nuanced shift in the wording of the assessment, and the specific mention of the “next” meeting created a powerful incentive to market participants to re-price the risks of a December hike.  This was immediately reflected in the US debt instruments and the dollar.  Of note, the divergence theme that we emphasize has driven the US-German 2-year interest rate differentials to new cyclical highs.
  • The FOMC statement downgraded the risks emanating from abroad.  Of course, the Fed will continue to monitor such developments, but barring a negative surprise, the Fed does appear poised to hike rates.  Fed officials may have found comfort in recent developments.  Emerging markets and China have stabilized.  Equities are doing better.  The VIX has tumbled.  There has been no confirmation in the weekly jobless claims of the deterioration in the labor market seen in the past two national jobs reports.  
  • The advance report on the US September trade balance showed a smaller than expected deficit owing in part to unexpectedly strong US exports (merchandise exports +2.5% ‎in September).  This lends support to the hypothesis that the dollar’s impact is transitory. It also spurred a reassessment of Q3 US GDP.  Estimates have been raised, but it will likely be a soft quarter.  However, the FOMC statement upgraded its assessment of household spending and business fixed investment.  This points investors toward focusing on the final domestic demand GDP, which may be a little over 3%, as headline activity was likely held back by net exports (not as much as it appeared at the start of the week) and inventory drawdown.
  • Rates markets reacted accordingly.  The Fed Funds futures strip added on 5-10 bp across the curve, while the 2-year UST yield rose 8 bp to 0.70%.  This boosted the US-German 2-year differential to 105 bp, new cycle highs.  Markets were clearly set up for a dovish Fed and we didn’t get it.  Positioning skew may give this move a bit more staying power than it might normally have.  Lack of follow-through in the markets has been one of the major complaints recently.
  • The euro made new lows for this move, the lowest since August 10 and on track to test the July 20 low near 1.08 despite today’s small bounce.  German state CPI readings have trickled out, supporting market consensus that the national reading out later today at 9 AM EST will show a slight easing of deflationary conditions in October.  Cable softened too but held up relatively better, driving the EUR/GBP cross below .7150 before recovering a bit today.  EM currencies have softened as well, and are likely on track to revisit the lows from earlier this year.
  • During the North American session, the US reports weekly jobless claims, advance Q3 GDP, and September pending home sales.  Some German states have already reported October CPI, but the nationwide reading will be released at 9 AM EST.  Consensus is at 0.2% y/y (0.0% y/y EU harmonized).  Germany also reported October unemployment data earlier.
  • Late yesterday afternoon, the RBNZ left rates steady at 2.75%.  While this was consensus, a small handful looked for a 25 bp cut.  Still, the RBNZ left the door wide open, saying that further easing “seems likely” but data-dependent.  It added that a sustained rise in NZD would require a lower interest rate path.  This helped push the Kiwi lower to around .6625 yesterday, but it has not made fresh lows yet today.  The next RBNZ meeting is December 10 (afternoon of December 9, NY time).
  • Overnight, Japan reported some more data ahead of the Friday BOJ meeting.  September IP came in much stronger than expected at +1.0% m/m vs. -0.6% consensus and -1.2% in August.  On a Q/Q basis, however, IP fell 1.3% in Q3, the second consecutive quarterly drop.  Still, the stronger data is in line with our view that markets have been overestimating the odds of an immediate move by the BOJ to expand QE.
  • Surveys suggest that around 40% of investors expect the BOJ to expand its asset purchases program when it meets tonight. We are less convinced.  Moreover, many real money clients spoken with think the BOJ sticks with its current target of increase base money by JPY80 trln a year.  This raises the possibility that the surveys are not sufficiently up-to-date.  There appears to be no pressure from the Abe government on the BOJ.  Finance Minister Aso and two government advisers have downplayed the need for more action now.  BOJ officials we have spoken with of course did not reveal what the central bank will do, but they pushed back against the arguments that emphasize the urgency of new action.
  • BOJ officials recognize that GDP may have contracted in the July-September quarter.  However, this also did not seem to instill a sense that a monetary policy response was required.  The problem is that potential growth is so low that the normal variance could see an occasional drop into negative territory without signaling economic deterioration.   Boosting trend growth is not a function of monetary policy, but underlies Abenomics 2.0.  
  • Brazil reports October IGP-M wholesale inflation (10.2% y/y consensus).  COPOM minutes will also be released, and should provide some more information on why convergence with the inflation target was pushed out to 2017 at that meeting.  September consolidated fiscal data will also be reported.  Market expectations are mixed, with the 12-month primary deficit seen narrowing but the 12-month nominal deficit seen widening.  
  • Mexico central bank meets and is widely expected to keep rates steady at 3%.  Mid-October inflation came in at another record low of 2.47% y/y, supporting our view that Banxico should not be in any hurry to tighten.  September trade data was softer than expected, with exports down y/y for the third straight month.  It wasn’t just oil, as manufactured exports have fallen y/y for two straight months now.  
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