December 15, 2016

Markets Today: Two become three

The US Fed delivered their anticipated 25 basis point rate hike this morning, but they surprised markets by announcing an expectation of three further rises in 2017, one more than previously anticipated.

As expected the Fed lifted the Federal Funds rate target by 0.25bps taking the range to 0.5%-75% from 0.25%-0.5%. More importantly, however forecasts for the future Fed Funds rate path (the so called dot plot) now suggest 3 hikes in 2017 versus 2 previously and three hikes in 2018 and 2019, same as before. This is the first increase in the dot points since September 2014 and interestingly, as well, now there is a greater dispersion in the forecast, suggesting a wider range of views and a tinge of more hawkishness than before. For example, previously in 2017 2 hikes had 7 votes, now 3 hikes has 6 votes and 4 hikes has 3 votes. Similarly in September 2018 3 hikes had 7 votes and now 3 hikes has 5 votes and four hikes has 3 votes. So while the median for 2018 is unchanged, there is certainly a bias for more hikes than before.

Reading through the Statement, the Committee’s expectations of further expansion in economic activity as well as additional strengthening in the labour market and further rise in inflation were cited as the reasons for raising the target range for the Federal Funds Rate. The new set of forecasts shows a very mild upward revision to GDP growth, for 2016 GDP growth is now seen at 1.9% vs 1.8% previously and 2017 is now seen at 2.1% vs 2.0%. The unemployment rate in 2016 is now seen at 4.7% vs 4.8% previously and 4.5% in 2017 versus 4.6%. Meanwhile core PCE and headline PCE have been left unchanged, however the Statement recognizes the pick-up in inflation and it notes inflation compensation has moved up “considerably”. On this score it is interesting to note that Fed Chair Yellen said that some FOMC participants adjusted their forecast based on expectations of further fiscal stimulus.

Market reaction to the more hawkish Fed outlook has seen the USD rise across board while US Treasury yields have also shifted higher with the move led by the front end of the curve. Meanwhile US equities have fallen sharply on the news with the Dow, S&P and NASDAQ down between 0.5% a 0.80% as we type.

Looking at currencies in more detail, NOK (-1.66%) and Yen (-1.18%) are at the bottom of the pile, essentially following the moves in oil and US Treasury yields respectively while the AUD and NZD are about 1% lower reflecting the increase in risk aversion. Meanwhile GBP is the best G10 performer, winning the least ugly contest.

Unsurprisingly prior to the Fed announcements markets were essentially marking time. US equities were traded in a narrow range, oil prices drifted lower throughout the night and USD was a little changed against most currencies, barring the CAD and the NOK which were seemingly affected by the retreat in oil prices.

As for data releases overnight, US data came out on the disappointing side and played into the softer USD tone pre FOMC. US retail sales printed below consensus across the board (0.1% vs 0.3%e, ex auto +0.2% vs 0.4%e and control group 0.1% vs 0.3%e) and industrial production fell by 0.4% in November below consensus of -0.3%.

UK unemployment held steady at 4.8%, but the employment change (-6k vs 50ke) was a big miss while average earnings (ex bonus) were a bit stronger. Cable was unperturbed by the data and indeed it managed to climbed above 1.27 pre FOMC, buoyed by the broad USD weakness seen prior the announcement.

Coming Up

We have another full calendar today starting with Australia’s labour force report, PMI data in Europe and Bank of England’s policy announcement followed by US CPI figures along with activity and housing data releases.

NAB expects that Australia’s unemployment rate will remain unchanged at 5.6% (in line with consensus) while employment growth for the month is seen at 13k, slightly below market expectations of 17.5k. As usual, the well-known limitations of the survey along with its volatile nature mean that we should not place too much weight on the monthly change in employment. Instead, more attention should be given to the unemployment rate which in our view is a more reliable short-term indicator of labour market health. Importantly as well, this mid quarter release provides estimates of under-employment and the under-utilisation rates. Unlike the unemployment rate which has been trending lower in recent months, the under-employment rate (those wanting to work more hours than they are currently working) has been rising and this is a measure the RBA has been highlighting as one of the reasons why the labour market has been “more mixed” than what the headline rate might suggest.

Germany’s preliminary PMIs for November should confirm economic activity in Europe’s largest economy remains in expansionary mode and it should help reinforce the view that the economy continues to accelerate in Q4.

Ahead of the BoE policy announcement, the UK releases its retail sales figures for November and the market is looking for a flat outcome on the monthly reading which should drag the year on year figure to 6% from 7.6% previously. As for the BoE, no surprises are expected. The Bank Rate is expected to remain unchanged and the minutes are anticipated to reiterate the committee’s neutral bias over the near term.

The US November CPI figures are likely to show a monthly rise of 0.2% for both the core and headline numbers. On a year on year basis, core inflation (2.2% vs 2.1%) is still expected to outpace the headline reading (1.7% vs 1.6%), but market’s attention is likely to be centred on the extent to which labour costs push core inflation higher. The Philly Fed and Empire state surveys are also due for release along with weekly jobless claims, Q3 current account and the NAHB housing market index


On global stock markets, the S&P 500 was -0.61%. Bond markets saw US 10-years +6.07bp to 2.53%. In commodities, Brent crude oil -3.45% to $53.8, gold+0.4% to $1,161, iron ore -5.1% to $79.18, St. Coal +1.8% to $87.55, Met. Coal +0.0% to $270.00. AUD is at 0.7415 and the range since yesterday 5pm Sydney time is 0.7414 to 0.7522.

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