The Fed's divided house
- FOMC minutes reveal September hike decision was very close
- Negative Chinese trade shock hits equities, risk sentiment
- GBP may still have room to climb versus the euro
and the latest news from the Fed. Photo: iStock
By Neil Staines
“If you follow the trend, you will always be right behind it” — Lindsey Haun
Last night, the market's’ primary focus of attention shifted away from the GBP, the UK and Brexit – at least temporarily. Instead, the release of the minutes from the September 21 Federal Open Market Committee meeting in Washington brought US policy normalisation, interest rate differentials, and equity valuations back to the fore.
The key strapline from the September statement was the fact that the rate decision in September was (for several) a "close call". While many members reiterated that they saw “few signs of inflation pressure” and many viewed “some labour market slack remaining”, the Fed officially noted that a “reasonable argument could be made” for a rate hike.
Effectively, this leaves us in a situation where there is likely not enough urgency to hike just before the election and that ceteris paribus, the Fed will take another baby step to rate normalisation in December.
From our perspective, however, this is a very important caveat. No sooner had the minutes been delivered than lower US (and global) bond yields, sharply weaker Chinese trade data, and a significant drop in US equities complicated the backdrop.
The near-term macroeconomic progression of China will likely become the dominant protagonist in the case for a December US rate hike, though all three are likely to be key in global market and consumer sentiment.
The trend in Chinese exports remains weak; at the same time, non-financial company debt burdens are increasingly troublesome. This development is likely captured in the Fed minutes under the comment “officials still saw important downside risks abroad” and further negative developments here will likely be enough to halt the Fed once more.
A tightening labour market is the main argument for raising rates in the US, even as rising participation has halted the decline in the unemployment rate itself. Wage growth is (slowly) trending higher, but even among those favouring a rate hike at this stage, none are suggesting that the pace of hikes picks up to any significant degree.
With oil prices back below $50/barrel, there may be room for some of the recent US curve steepening to be unwound and if (as we would anticipate) equity markets accelerate to the downside, then we would favour the JPY to regain some of its recent lost ground in FX.
As far as equities and USDJPY are concerned, the phrase "caveat emptor" is likely just –particularly if, as we fear, the Q3 earnings season in the US disappoints.
"Not all those who wander are lost" — J. R. R. Tolkien
With little on the data calendar to distract markets today, it is likely that GBP regains prominence as a focal point for the expression of negative sentiment. Earlier in the week we discussed our views that the negative sentiment towards GBP was becoming overdone, stating that in the long run “the UK economy will be stronger, more flexible and progressive outside the regulatory confines (and lack of direction) that defines the EU”.
We have also argued that it is very unlikely that the pain of divorce from the EU will be felt only on the UK side, and that in that regard GBP is beginning to offer value against the EUR.
While we concede that the lack of clarity surrounding the Brexit negotiations undermines GBP from a political standpoint, we have gone beyond the point that the correlation between interest rate differentials and currencies is becoming overstretched. Furthermore, it is likely that the drop in GBP has more than compensated for the negative implications for UK growth (at least under current projections).
With the Swiss and Chinese authorities firmly backing their cooperation with an independent UK this week, there are reasons to be more optimistic about the UK and GBP. As the (political) uncertainty fades, the case for GBP, at the very least relative to rate differentials and growth projections (not to mention a longer term fair value metric), are potentially significant positives for sterling.
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group