Central Banks To Dictate Next Market Move

Wednesday July 27: Five things the markets are talking about

Investors will need to watch this afternoon’s FOMC statement on monetary policy closely. The central bank is not expected to move interest rates this week, but any hints on the likelihood of a future rate rise could move markets.

With no press conference scheduled and no new economic forecasts to be released, the statement will be scrutinized for any clues to whether a September rate increase is in play.

There are a number of questions that are required to be answered. Investors will want to know how the Fed will describe the labor market, how they are monitoring global developments, how good is U.S growth, how do they see inflation and will there be any dissent?

The dollar continues to make gains ahead of the announcement, with the dollar index rising +0.1% ahead of the U.S open. Despite the market expecting the Fed to acknowledge the improved U.S. data, expectations for an immediate rate hikes have been scaled back since the U.K. vote to leave the EU on June 23.

Current market expectations are considered very cautious with dealers continuing to price less than a +50% chance for one hike this year.

1. Yen ‘ping-pong’ trading

Yen weakness will depend on two things, PM Abe’s fiscal spend and BoJ monetary policy. This week has been a guessing game when it comes to predicting a fiscal number. Early week yen’s strength occurred on the back of a disappointing guesstimate, however, that has all changed in overnight trading.

PM Abe said his government would compile a stimulus package of more than +$265b (+¥28T) next week to reflate the flagging economy, nearly double more than expected, however, it remains unclear how much would be spent to directly boost growth.

The package is expected to consist of +¥13T yen in “fiscal measures,” which likely includes spending by national and local governments, as well as loan programs. Abe’s announcement came earlier than expected and now puts pressure on the BoJ to match his big spending plan with additional monetary easing at this Friday’s BoJ monetary policy meeting.

The market now expects the BoJ to ease policy, including increasing government debt purchases. It’s all about perception; Abe will be able to say that his government and the BoJ are working together to reflate their flagging economy. Can the BoJ afford to disappoint?

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2. Pound under pressure despite Q2 GDP beating expectations

Next week’s August 4th BoE meeting should be diarized as its outcome is expected to have a big impact on sterling (£1.3102).

The pound is under pressure heading to the open stateside despite above-forecast U.K. Q2 GDP growth of +0.6% quarter-on-quarter print this morning. The little or negative impact to the currency is due to its pre-Brexit composition.

Comments this morning by new U.K. Chancellor Hammond suggest BoE easing is around the corner. He indicated that despite that U.K GDP data being “strong,” he is confident that the BoE and the government “will take whatever action is necessary” to support the economy after the country’s vote to leave the EU.

It’s difficult for the market to absorb the GDP release positively; especially given the recent IMF U.K growth downgrades and Governor carney itching to be proactive at next week’s meeting.

3. Global equities mixed reaction

Japan’s bigger-than-expected stimulus package, highlighted above, failed to lift shares in Asia beyond its home market overnight. The Nikkei Stock Average rose as much as +2.7% during the session, before paring gains to close up +1.7%.

Australia’s S&P ASX/200 was flat, South Korea’s kospi fell -0.1%, and Hong Kong’s Hang Seng Index ended up +0.4%.

In Europe, equity indices are trading higher ahead of the Fed’s policy decision. Financial stocks are currently mixed in the Eurostoxx, while the commodity and mining sector are providing some support to the FTSE 100 index.

Indices: Stoxx50 +1.0% at 3,010, FTSE +0.3% at 6,744, DAX +0.9% at 10,335, CAC 40 +1.5% at 4,461, IBEX 35 +1.3% at 8,669, FTSE MIB +1.2% at 16,890, SMI +0.4% at 8,260, S&P 500 Futures +0.2%

4. Rate divergence widens spreads

The Fed is not expected to change policy later today, however, stronger U.S. economic data of late has revived expectations of a Fed hike and markets see roughly an even chance of a rate rise in December.

However, the prospect of a “go-slow” stance by the Fed to raise rates is one of the factors keeping a lid on U.S. bond yields further out the curve.

U.S. 10-year notes currently trade at +1.565%, compared with +1.580% yesterday. Any uptick in yield seems to be short lived as fresh buying interest, particularly from pension funds, domestically and especially from Japan and Europe (NIRP policy), are there waiting to acquire high-grade long-term debt that offers decent returns.

U.S 10’s are trading in a relatively narrow range (1.366% to +1.60%) since its record low print three-week ago. Technically, it’s a tad premature to declare that the 10-year Treasury yield has seen the bottom. To record new record low prints the market needs to see a significant slowdown in the U.S. and the global economy.

Long term yields next move depends on the Fed’s normalization policy. Will the market get a better insight after today’s Fed statement?

5. Crude prices record new three-month lows

Oil prices remain under pressure, printing a three-month low this morning as high inventories of gasoline product weigh on the market.

Brent crude trades down -1% to $44.44 a barrel, while WTI has fallen -0.5% at $42.71 a barrel.

The markets focus has clearly shifted to high inventories of refined products, which is naturally pressurizing crudes recovery.

API data released yesterday showed a -827k barrel decrease in crude supplies, a -423k barrel decline in gasoline stocks and a +292k barrel build in distillate inventories.

In the U.S, despite the annual driving season, gasoline stocks are at +241m barrels, a level more than +12% above the five-year average.

Dealers are speculating that with the increased glut of gasoline stocks will prompt refiners to buy less crude oil going forward, causing the global glut of crude to linger longer and put prices under further pressure.

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Written By: MarketPulse