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From the Floor: Yellen and Fischer confirmed March hike — #SaxoStrats

  • Fed chief Yellen and vice chairman Fischer more or less confirmed March rate hike
  • Probability of March US rate hike rose to 94% after Yellen’s address
  • Question for the dollar now is further pace of tightening: Hardy
  • Only a very weak February US jobs report could deter Fed: Fasdal
  • European government bonds trend lower; US-Germany 10-yr spread extremely wide
  • Deutsche Bank plans raising €8 bn in capital, selling asset management stake 
  • Funds cut bullish WTI crude oil bets by 7% in week to February 28
  • Support for WTI seen at $52/barrel and for Brent at $54.45/b
  • Gold buying accelerated last week; net-long jumped 48% to 3-month high.
  • China trimmed 2017 GDP target at about 6.5%
SaxoStrats banner

By John Acher

The last two pieces of the puzzle snapped into place on Friday, when US Federal Reserve chief Janet Yellen and her sidekick Stanley Fischer more or less confirmed a March 15 interest-rate hike, the Saxo Bank strategy team says on Monday.

Market-implied probability of a March Fed rate rise soared to 94% after Yellen spoke on Friday, says trader Hong Wei Lee at Saxo Bank’s hub in Singapore. 

Yellen said on Friday that the Federal Open Market Committee would evaluate whether employment and inflation are evolving in line with its expectations, "in which case a further adjustment of the federal funds rate would likely be appropriate,” Bloomberg reported. Fischer said "there is almost no economic indicator that has come in badly in the last three months.”

”It’s more or less priced in now,” Saxo Bank’s FX strategy chief John J Hardy says of the March 15 Fed rate rise. (See also Hardy's FX Update here.)

Saxo’s fixed-income strategy chief Simon Fasdal says, “It’s only a very weak non-farm payroll on Friday that could change that sentiment.”

Despite the near-certain chances of a Fed March increase, market expectations for further Fed tightening remain basically unchanged.

“The dollar reaction was muted, and the dollar actually settled a bit lower into the close,” Hardy says. “We are not seeing anything out the curve with the pace of the hikes changing. We have notched higher the chances for March, [but] the end rate – if you look at the March 2018 Fed funds future – was actually priced a bit lower, probably because we saw a bit of a selloff in risk appetite.”

“As long as that pace does not increase further out, it is a question how much the dollar can get out of any Fed hawkishness, and that will be about further evidence from the economy and policy-making from Trump, which is lacking on specifics and timing,” says Hardy. 

That likely means something of a pause for the dollar, Hardy says, also because the FOMC seems unlikely to change its message about the pace of tightening at its meeting next week.

“It’s a bit worrisome for dollar bulls here as we have to wonder what the catalyst is for picking up the pace out the curve on the Fed,” Hardy says.

Saxo’s Fasdal notes that Yellen also spoke on Friday about global risk factors, such as Brexit and Chinese credit growth, would remain a challenge. “That shows less hawkishness in our view, and is one of the factors why the US 10-year yield actually dropped to 2.47% from 2.51%,” Fasdal says.

Fed outlook

European government bonds are trending lower, with 10-year Bunds beaten again.

“Improving data and rising inflation seem to override the uncertain political outlook for the moment, and that could bring a lot of action from the ECB meeting on Thursday,” Fasdal says. “We expect a revision of the forecast to both growth and inflation.”

“On the back of that, there is a small chance that we see Draghi at least addressing the present QE versus the development in reality in Europe where we see higher inflation and growth,” Fasdal says.

Fasdal also points the extremely wide spread – above 200 basis points – spread between 10-year US and German bonds as something to watch as a "reality check" on the bond markets.

US-Germany 10-year spread is "extremely wide"
 Source: Bloomberg and Saxo Bank
Mexican peso leaps

The Mexican peso jumped, and USDMXN plunged, after US commerce secretary Wilbur Ross talked on Friday about a new Nafta deal that would strengthen the peso. 

"I believe that if we and the Mexicans make a very sensible trade agreement the Mexican peso will recover quite a lot," Ross said on CNBC's Squawk Box on Friday.

Saxo's Hardy says it is clear that the US wants the Mexican peso stronger. "It makes no sense to bash Mexico and see its currency getting devalued by the market by 20-30% and making Mexico even more competitive and even more susceptible to outsourcing, exports and so forth,” he says.

“The Mexican peso is undervalued, and a strong comeback [on Friday], and we have been touching the 200-day moving average a couple times, so let’s watch that this week – watch for a potential break lower [in USDMXN],” Hardy says.

Peso jumps, USDMXN plunges
Source: Saxo Bank 

Muted RBA expectations

The Reserve Bank of Australia meets tonight, but Hardy says expectations are muted, and it would be a big surprise if the RBA said anything hawkish.

“Basically we have an RBA [outlook] that is flat, and hoping that the Australian economy comes back, “ Hardy says, adding that 0.75 is technically a “massive area” for AUDUSD, with the 100- and 200-day moving averages both there, as well as the previous high and a Fibonacci retracement area. “So this support needs to hold to keep the upside in focus,” Hardy says.

AUDUSD - 0.75 is technically key
Source: Saxo Bank

On the calendar this week, Monday is mainly quiet, though European Union leaders gather in a “mini EU summit” in Versailles, and that is worth watching for any signals about Brexit. The European Central Bank meets on Thursday, and the US February employment report is due on Friday.

Volatilities down

In the FX options market, volatilities traded considerably lower across the board last week, especially on Friday when there was a selloff in the middle of the curve and further out.

Three-month EURUSD volatilities, which cover the French presidential election, dropped on Friday by 0.9 vol to 9.35, “Which is a huge move, as you can see on the chart,” says Saxo Bank FX options trader Jeppe Norup. “This is actually the lowest we have since the three-month has covered the French election.”

3-month EURUSD at-the-money
Source: Saxo Bank
Several factors account for the big selloff in volatilities last week: the right-wing populist presidential candidate Marine Le Pen is losing ground in the polls, risk-on sentiment in the stock markets is also removing some demand for protection in volatilities, EURUSD risk reversals now favour euro puts, and the March 15 rate hike is already priced in, so the FOMC meeting is seen less volatile, Norup says.

Deutsche ups capital

Deutsche Bank announced plans to raise €8 billion in capital and sell a minority of its asset management business through a public offering.

“They are proposing a dividend of 19 cents. That’s actually the key and interesting thing because the market consensus was for no dividends for the last fiscal year, so that could be a positive spin on this whole capital raising,” says Saxo Bank’s equities strategy chief Peter Garnry. 

“The story behind it is that the new CEO, [John] Cryan, is turning around, he is pivoting 180 degrees on his first strategy and abandoning the strategy to sell the Postbank and instead going for reintegrating it into the remaining Deutsche Bank commercial business,” Garnry says.

The capital injection will lift Deutsche Bank’s common equity tier-one (CET1) ratio to 14.1%, which would make it one of the stronger banks in Europe. 

“And that’s the capital needed to really grow that part of the business and still be a dominant player in the capital markets, so I think the market will take this as positive news long term, and it could be one of the key drivers if they continue with the cost-cutting programme,” Garnry says.

Commodities sold

The commodities market has been seeing wobbling investor positioning, with reductions in positions last week, which was reflected in flat major indices despite a massive build-up in long positions at the same time.

“We saw that in oil last week,” says Saxo Bank’s commodities strategy chief Ole Hansen. “Funds are at this stage holding non-performing or loss-making positions, and that led to the first cut last week.” (See also Hansen's report on funds cutting their bullish bets here.)

Funds cut bullish bets on WTI crude oil by 7% in the week to February 28, which was the first reduction in five weeks and the biggest since early November, Hansen says. 

“The focus is still on the rigs, a Libyan port closure, which helped the market bounce on Friday, and the slowing growth in China,” Hansen says.

This week the oil market will be watching the annual CERAWeek in Houston, where the “titans of the oil world” will gather.

Saxo Bank maintains a short bias and sees support for WTI crude at $52/barrel and for Brent at $54.45/b. “These are the two levels at the moment to look out for,” Hansen says.

Gold buying accelerated last week when the price challenged but failed to break its 200-day moving average, and corrected later in the week, Hansen says.

Saxo maintains a long bias on gold above $1,220/oz, with resistance at $1,262, he adds.

Federal Reserve in Washington
 Fed policymakers have all but promised a March 15 rate hike. Photo: Shutterstock 

Editor’s note: From the Floor takes advantage of's unique real-time access to Saxo Bank’s various trading desks around the globe to put our community in touch with the developments that matter to their portfolios.


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