Markets Today: Fed balance sheet in focus

It was a busy overnight session packed full of data that led to some intraday moves.

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It was a busy overnight session packed full of data that led to some intraday moves. ADP payrolls (better than expected) and the Non-manufacturing ISM (worse than expected) gave contrasting reads on the labour market, while the FOMC Minutes confirmed that a change to the reinvestment policy was likely later this year. Equities initially rose then fell along with US Treasury yields, while the US dollar was broadly unchanged.

On the FOMC Minutes, the US Treasury market focused in on the balance sheet comments with yields down 2.5 bps to 2.34%. The Fed said it was considering ending or slowing reinvestment of Treasuries and mortgages ‘later this year’ and there was no suggestion of actively selling assets. These comments were seemingly interpreted as implying less need for Fed rate hikes given a phasing down of the reinvestment policy could act as a defacto tightening, while the path of tightening could also be delayed as the Fed would want to assess the impact of the phasing down on the market (also conveyed by the Fed’s Dudley last week).

For your scribe, comments on the uncertainty over the inflation outlook are also worth noting. “Several” participants noted inflation had not picked up despite a strengthening in the labour market, while “Other[s]” were concerned that if the labour market ran above its full-employment level then it “posed a significant upside risk to inflation”. How these camps interpret the improving labour market will thus be key for rates. The OIS market currently prices a 55% chance of a June hike, while 1.4 rate hikes are priced in for the rest of this year.

ADP Payrolls again shot the lights out, up 264k against expectations of a 185k rise. The correlation with Friday’s official Non-farm Payrolls has improved over the past year (see Chart) and is suggestive of upside risk. One caveat to this is a snowstorm in the northeast of the US in the week that payrolls were surveyed, so it is possible official payrolls are affected. The Atlanta Fed’s jobs calculator suggests it only takes 120k payrolls a month to keep the unemployment rate steady and anything north of this will still be viewed positively by the Fed.

The Non-manufacturing ISM disappointed falling to 55.2, below the consensus of a rise to 57.0. Under the hood, the employment sub-index was weak and registered a seven-month low of 51.6. At first glance that could be suggestive of payrolls growth slowing in the coming months. However, seasonal adjustment issues around Easter could have impacted. The commentary was also less positive with some noting gridlock in Washington over healthcare reform. Speaker of the House Paul Ryan seemingly reinforced this point overnight stating tax reform could take longer than health (which isn’t resolved yet).

In FX, the UK Pound was the clear outperformer up 0.4% to 1.2481 and within a hairs breadth of punching through 1.25. A better than expected Services PMI contributed with the PMI rising to 55 against expectations of 53.4. The US dollar was broadly unchanged overnight, while the Euro fell (-0.1%), and the Aussie rose (+0.1%).

Comments by ECB governing council member Weidmann are worth noting ahead of today’s ECB Minutes even if they did not have a lasting impact on markets (German Bund yields ended the day up 0.1 bps to 0.26%). Weidmann advocated for tapering in the next year “not have the foot pressed down on the gas pedal, but to lift it slightly” and a full stop to purchases within a year.

Equity markets were lower on the day, with the S&P500 down 0.3% on the day (Eurostoxx also down by 0.3%). The price of Australia’s key commodities rose overnight, coking coal futures climbed 9.8% and hit $236 a tonne –well up on the $150 a tonne level it had been a few weeks early. Spot iron ore also rose 2.6% to $81.5 a tonne.

Coming Up

A busy day ahead on the international calendar with the ECB Minutes (9.30pm AEST), a number of central bank speakers (including Draghi), and the much hyped first meeting of President Xi and Trump.

Domestically, it is very quiet with only one item on the agenda being a speech by the RBA Deputy Governor Debelle (8.40am AEST) on ‘Recent Trends in Australian Capital Flows’. It will be interesting to see what Martin Place thinks of Australia’s narrowing current account deficit and whether this has any implications for the currency or longer-term interest rates.

The ECB Minutes will be closely watched for any discussion of tapering or of increasing the deposit rate. Weidmann overnight advocated for tapering and then a full stop to purchases within a year.

On the President Xi-Trump meeting, it is uncertain what outcomes will result. Geopolitically, it is encouraging they are meeting in the first place and if Trump’s weekend FT interview is to go by it could be more conciliatory then Trump’s recent rhetoric: “I would not at all be surprised if we did something that would be very dramatic and good for both countries and I hope so.” and “I don’t want to talk about tariffs yet, perhaps the next time we meet.” North Korea is likely to get a mention – especially after yesterday’s missile test.

Overnight

On global stock markets, the S&P 500 was -0.31%. Bond markets saw US 10-years -2.86bp to 2.34%. In commodities, Brent crude oil -0.20% to $54.06, gold-0.8% to $1,245, iron ore +2.6% to $81.54, steam coal -0.3% to $89.45, met.coal +9.8% to $236.00. AUD is at 0.7569 and the range since yesterday 5pm Sydney time is 0.7558 to 0.7586.

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