Aurelija Augulyte Eye-Opener: USD weaker ahead of Fedspeak, rates up but room for more Nordea Research, 02 November 2015
This week’s highlights: central bank policy meetings, Fedspeak and US jobs report Fed priced 50/50 for December hike USD weakens broadly, down from the range Recap
The stock markets were mixed on Friday, with the European stocks ending slightly higher (+0.14%) but the US S&P 500 finishing the week with -0.48% for the day. The Brent oil prices corrected yet stronger to USD 50/bbl as the US rig counts dropped again. Tonight in Asia the sentiment was mostly negative, with Japanese stocks being notable underperformers (Nikkei down 2% as we write).
China official manufacturing PMI came out at 49.8 on Sunday, exactly at previous month’s levels. The Caixin/Markit PMI released tonight came out higher than expected at 48.3. Both indicators show China’s industry sector is still challenged by structural issues, overcapacity and falling demand. But there are signs of stabilization which are seen as a result of past and ongoing government stimulus.
Turkey held parliamentary elections on Sunday, where AK Party unexpectedly won the majority. The Markets took the result with joy, with the Turkish lira gaining almost 4% over night.
Friday’s US data releases showing still muted PCE inflation and wage growth are not going to end the debate in the Fed about the need to hike rates in December. The decision will now probably mainly depend on the outcome of the next two jobs reports, including the one released by the end of this week. Still, partly because our Phillips curve model suggests that US wage growth will pick up to around 3% over the coming year, we continue nexus.nordea.com/research to believe that rising inflation pressures will imply that the Fed will raise rates faster than is currently priced in by markets. See US Phillips curve alive – and soon kicking?
The tiny increase in Euro-area inflation in October came as no surprise and will not have much impact on the ECB doves’ thoughts about more stimulus. Further base effects stemming from last year’s steep fall in energy prices will dominate the inflation picture until the turn of the year. We expect the headline inflation rate at 1% y/y by January 2016, up from 0.0% in October.
On Friday the US Congress passed a two-year budget plan that avoids a government default and a shutdown, removing one obstacle for a December Fed rate hike.
In case you missed it, we released the note China: a plan for the next five years, where we discuss the implications of the abolished one-child policy, a lower growth target and growth transition to a new normal. The note Danish central bank barricades itself when the ECB opens the floodgates looks at the implications for DKK rates of more policy easing from the ECB.
Day ahead
Today in Europe, we get the final October Euro-area PMIs and the first reading of the October UK PMI. In the US, focus is on the ISM manufacturing index.
After three consecutive declines, we expect the ISM manufacturingindex to edge up to 50.5 in October from September’s 50.2, consistent with continued weakness in manufacturing. However, as suggested by continued labour market strength the performance of the manufacturing sector is not a particularly good indicator of the broader US economy anymore. Manufacturing accounts for only 12% of GDP and 9% of employment.
Tomorrow morning the Australian central bank will announce its interest rate decision. Analysts are split between a rate cut and an on-hold decision. We expect no change. In Denmark, focus will be on October FX reserves data. nexus.nordea.com/research On Wednesday all eyes will be on New York Fed President Dudley, who gives a speech on the US economy. Will Dudley leave the door open for a December rate hike or not? We expect he will. Fed Chair Yellen testifies in Congress on bank regulation, so we expect no comments from her on monetary policy. Moreover, the US non-manufacturing index and the ADP employment indicator for October are due.
On Thursday speeches by Fed Vice Chair Fisher, Fed Governor Tarullo and Atlanta Fed President Lockhardt plus ECB President Draghi could be very interesting. So will the signals from the Bank of England’s MPC meeting. No policy changes are expected now, but the BoE’s guidance will be important. Our forecast is still that the BoE will start hiking rates in Q1 2016. In the Nordics, focus is on Norges Bank’s rate decision. We expect no changes to rates.
Friday is time for the US jobs report. After two soft months we expect a 200k gain in non-farm payrolls in October. The unemployment rate is expected to remain at 5.1%, while average hourly earnings could see a 0.3% rise. Such an outcome would be supportive for our call that the Fed will hike rates in December. In addition, focus will be on industrial production data from Germany and the UK.
nexus.nordea.com/research Click here for full calendar
Rates
The German 10-year yield was barely changed on Friday after the 10 bp rise the day before. The EUR interest rate volatility has clearly increased, but according to Draghi in June, volatility is here to stay and the ECB will look through that. A slight uptick in inflation on Friday did not do much to convince us that the ECB will not deliver in December: a 10 bp deposit rate cut is still priced in. But the bias in rates is clearly on the upside now that we will see higher inflation in coming months.
USD short rates rose over the past week, with the USD 2Y swap ending the week 10 bp higher. Clearly the December rate hike has been brought back to market expectations, with a current 50% probability of 25 bp lift-off in December, with the first hike discounted in 4 months. Fed’s Dudley, Fischer, Yellen – the top trio – are to speak this Wednesday, Thursday. With their dots for the first hike in 2015, any nexus.nordea.com/research change in views matters. We believe they will stick to the plan, supporting further rise in USD yields.
FX
The USD was down on Friday, reversing from the upper end of the range we have seen since February this year. This makes room for further downside short term. The Emerging Markets currencies appreciated, correcting the downside of the Fed meeting shock earlier last week, with the PLN being a notable outperformer on Friday. The week starts with the TRY gaining 4% vs USD tonight as a result of a positive election outcome.
The GBP has been hit lately, with the BoE hike expectations being moved forward. But with the solid wage growth lately, the BoE should keep the door open this week for an earlier hike than the market prices in (in 11 months vs Nordea in Q1 2015), making space for GBP strength, especially against the USD. The EUR/GBP seems “fair” around 0.72 according to market and macro indicators.
The EUR/SEK and EUR/NOK have room to move toward 9.30 short term, but short term upside is possible on the days were stock market corrects down. With Norges Bank on hold this week, the NOK more than 3% weaker than Norges forecast, and oil prices back close to USD 50/bbl, NOK should be supported. The NOK/SEK is likely to fight for a position above parity again.
The BoJ did not increase its QE on Friday, with no big impact on JPY eventually. If rates go up from here as equity prices do globally, it is likely the JPY will be under pressure, although it is hard to see much room for the upside in USD/JPY due to valuation and positioning, in particular especially now that the BoJ is refraining from more QE.
Read more about our financial forecasts here.
nexus.nordea.com/research Chart of the day: US ISM manufacturing to show continued weakness
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