Market Brief: Fed Fears Dampen Market Enthusiasm
Traders are moving onto a more cautious footing today as the prospect of a ‘hawkish hold’ at tomorrow’s Federal Reserve meeting comes into view. The dollar is trading on a modestly weaker footing against the yen and euro, but is maintaining strength relative to most other majors as interest rate differentials continue to provide lift. The Canadian dollar is softening ahead of a much-awaited gross domestic product report.
Yields were left unmoved yesterday afternoon after the Treasury said it would borrow more than expected over the coming quarter. According to its updated quarterly refunding plans, the federal government will issue $243 billion in new debt in the April-through-June period, up roughly $41 billion from its previous forecast as tax receipts weaken. On Wednesday, more detail will be provided on the mix of maturities to be auctioned, but a repeat of last year’s upset looks increasingly unlikely to materialise - traders are well prepared, and officials seem intent on minimising disruption.
The euro is cutting its losses after simultaneous data releases showed growth accelerating and inflation slowing more gradually than expected. Led by a resurgent German economy, the currency bloc pulled out of recession in the first quarter, expanding 0.3 percent in aggregate. Core consumer prices climbed 2.7 percent year over year in April, down from 2.9 percent in the prior month, but above the 2.6 percent expected in financial markets. A decline in the services inflation aggregate from 4-percent year-over-year to 3.7 percent - paired with ongoing weakness in domestic demand - should provide the European Central Bank with some comfort, helping keep a June rate cut firmly on the table. Three moves are now priced in before the end of the year - down from as many as eight back in January.
Tensions within China’s two-speed economy grew more profound in April. The latest round of purchasing manager surveys showed the manufacturing sector continuing to generate gains from global demand and government support, falling by a smaller-than-expected margin to 50.4 after a (likely aberrational) jump to 50.8 in March. In contrast, the non-manufacturing index - more representative of underlying demand conditions - tumbled to 51.2 from 53 in the prior month, well below consensus forecasts for a print closer to 52.3. An update from the Politburo last night pointed to further stimulus efforts, with hints emerging around a pivot toward more government spending and easier monetary policy settings - but institutional incentives and the leadership’s preference for building up the country’s export prowess seem likely to widen the gap between inward- and outward-facing sectors in the economy.
We’re growing more confident in the belief that Japanese authorities intervened in currency markets yesterday, but the directional price effects are fading fast. Despite repeated retracements, the yen is coming under sustained selling pressure as traders bet on a ‘hawkish hold’ from the Federal Reserve at tomorrow’s meeting, and rate differentials widen in the dollar’s favour. Although speculative short positions have taken severe damage since Friday’s close, market momentum is likely to carry the dollar-yen exchange rate back toward the 160 mark in short order - unless the Fed turns suddenly and unexpectedly dovish.
Claims that Japan is facing an emerging market-style “currency crisis” have grown louder. But we’re reminded of something the Nobel prize-winning economist Simon Kuznets once said: “There are four types of countries in the world - developed, undeveloped, Japan and Argentina”. Japan simply does not resemble an emerging market country - or any of the advanced economies - and isn’t suffering a currency crisis in any meaningful way. There are parts of the economy that are suffering as the yen declines - namely household consumption and domestically-focussed corporates - but Japan Inc. remains long offshore assets, which are increasing in value. With foreign exchange reserves totalling more than $1.2 trillion, and a net international investment position amounting to $3.4 trillion, the country has an abundant war chest that can be deployed against currency weakness, and is well insulated from any outflow of capital.
Tomorrow’s trading session could prove intense. The latest job openings numbers and an update from the Institute for Supply Management - increasingly a market driver - will hit a few hours ahead of the Fed’s latest decision, with traders on tenterhooks throughout the post-announcement press conference. Plans to begin tapering the central bank’s balance sheet rolloff could provide a mildly-stimulative offset, but with growth and inflation data continuing to top expectations, Chair Powell is expected to soften his bias toward cutting rates, warning that policymakers are in no rush to start easing. Turbulence is quite possible, with subtleties and nuances - imagined, or otherwise - likely to drive major shifts in rate pricing.
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