June 15th, 2016 7:15 am
Via Marc Chandler at Brown Brothers Harriman:
Four Developments Ahead of the FOMC Meeting
- The FOMC meeting, with updated economic projections and a press conference, is the key event of the day
- First, MSCI has chosen not to include China’s A shares in its emerging market indices
- Second, there are no fresh developments on the UK referendum, and this is allowing sterling to bounce
- Third, global capital markets are in a correction mode
- Fourth, oil prices are softer following news of an unexpected US inventory build as estimated by API
The dollar is mostly softer against the majors. Sterling and the antipodeans are outperforming while the Swedish krona and the Swiss franc are underperforming. EM currencies are mostly firmer. RUB, MXN, and ZAR are outperforming while PHP, RON, and TWD are underperforming. MSCI Asia Pacific was up 0.2%, with the Nikkei rising 0.4%. MSCI EM is up 0.5%, with Chinese markets up nearly 1.5% despite the disappointing MSCI decision. Euro Stoxx 600 is up 1.3% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is up 2 bp at 1.63%. Commodity prices are mixed, with oil down 1.5% and copper up over 2%.
The FOMC meeting, with updated economic projections and a press conference, is the key event of the day, even though three other central banks meet over the next 24 hours. There are four things investors should know before the FOMC meeting.
First, MSCI has chosen not to include China’s A shares in its emerging market indices. Several large banks had played up the chances and emphasized the reforms that have been announced since last August. Of the 23 participants surveyed by Bloomberg, 10 expected the A shares to be included and another 8 thought it was too close to call.
We were less sanguine, and MSCI spoke to our concerns. Essentially the MSCI decision, which did not seem particularly close, was based on two main considerations. First, more reforms are needed. Second, more time is needed to evaluate the effectiveness of recently announced measures. MSCI specifically cited the 20% monthly repatriation limit as a significant hurdle, which we think alone may have been a deal-breaker.
A decision to include the A-shares appears to be at least another year away. Note that Vanguard’s FTSE emerging market ETF includes A-shares. Nevertheless, foreign investors have very little direct exposure to China’s onshore market. Estimates, based on the quotas granted, suggest foreign investors have about $180 bln in onshore yuan assets, nearly evenly divided between equities and debt. There is a slight bias toward the latter, which may reflect the preference of reserve managers.
Chinese shares initially sold off on the news but quickly rebounded. The Shanghai Composite finished 1.6% higher. It is the second advancing sessions and the best two-day run this month. Some suspect that officials supported the equity prices today.
Second, there are no fresh developments on the UK referendum, and this is allowing sterling to bounce. It is gaining for the only the third session in the past eight. Sterling is the strongest of the major currencies today, gaining a little more than 0.5% against the US dollar to edge ahead of the Australian and New Zealand dollars. Some who favor the UK to remain in the EU may have overstated their case by blaming the economic slowdown to Brexit fears. The economy has been slowing gradually for a year, or more, and the most recent economic data has surprised on the upside.
The better than expected industrial and manufacturing data has been followed by a favorable employment report today. The ILO unemployment measure unexpectedly edged down to 5.0% from 5.1%. The claimant count fell by four hundred, though the April figure was revised higher (to 6.4k from -2.4k). The number of employed rose by 55k to 31.6 mln and the number of unemployed fell by 20k to 1.67 mln.
Earnings are reported with an extra month lag but were stronger than expected. In April, average weekly earnings were flat at 2.0%. Many expected the pace to fall to 1.7%. Excluding bonus payments, average weekly earnings rose 2.3% from a revised 2.2% (initially 2.1%). The median expectations were for a 2.0% rate. The 2.3% increase is the strongest since last September.
Third, global capital markets are in a correction mode. The MSCI Asia-Pacific Index posted a minor gain to snap a four-session decline. The Dow Jones Stoxx 600 is up 1.4% near midday in London to break a six-session 7.5% drop. It is in a broad advance today, with all sectors up more than 1% except energy. Core bond yields are slightly firmer, while peripheral European bonds are seeing a 2-3 bp decline in 10-year benchmarks.
In the foreign exchange market, the greenback is seeing yesterday’s gains against most of the majors trimmed. The yen and Swiss franc are marginally lower on the day. Still, the dollar is holding below the previous day’s high (~JPY106.42) for the third consecutive session. However, thus far, the dollar is holding above the previous day’s low (~JPY105.63), also for the first time this week.
Fourth, oil prices are softer following news of an unexpected US inventory build as estimated by API. The official DOE estimate will be reported later today. The July light sweet futures contract continues to flirt with the four-month uptrend. After closing last week below the 20-day moving average, the contract has sent the first half of the week below it.
Ahead of the FOMC meeting, the US reports producer prices, Empire State manufacturing survey (June), and industrial output. After yesterday’s import price surprise, the risk to PPI is on the upside. Industrial and manufacturing output may be softer after a 0.7 and 0.3% respective gains in April. The Empire survey is expected to show modest improvement. Note that the Atlanta Fed’s GDP tracker now shows Q2 GDP growing by 2.8% after yesterday’s data, up from 2.5%.
While the FOMC is not expected to change rates today, the key to the markets’ response depends on two elements. First, to what extent does the FOMC statement preclude a July move? Second, do the Fed’s economic projections maintain the outlook for two hikes this year, which is suggested in its March forecasts? In its data-dependency posture, we think the Fed must keep the door open to a July move. We expect the dot plots to be consistent with two hikes this year, but suspect that next year’s four hikes may be trimmed.
South Africa will report April retail sales, which are expected to rise 2.5% y/y vs. 2.8% in March. Recent real sector data have been weak, even as price pressures have been rising. Next SARB policy meeting is July 21, and we think it will be a tough decision. It’s too early to make a call now but if rand weakness persists, the SARB will most likely restart the tightening cycle then after pausing at its last meeting May 19.
Israel reports May CPI, which is expected to remain steady at -0.9% y/y. Deflation persists, and this is well below the 1-3% target range. For now, the central bank remains on hold, as it is hesitant to use unconventional measures. Next policy meeting is June 27, and no change expected then. Press reports suggest the central bank is concerned about the growth in household credit, which suggests reluctance in cutting rates further.
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