20141217 – BAD HABITS

Apologies for the late blog, too many meetings this morning!


The last 2 days US equities have fallen dramatically into the New York close, it’s getting to be a bad habit. Tonight we have the FOMC, where Federal Reserve governors will announce their guidance to a nervous investment community. Is it possible that the crisis in Russia, will temper their hawkishness? Sadly I doubt it. As I’ve said over the last few weeks, the collapse of the Russian rouble does not happen in isolation, if anyone thinks that there isn’t going to be collateral damage from this, please let me know what they’re drinking, it must be the good stuff! My concern is that some banks or corporates must be on the wrong side of the collapsing rouble and will be experiencing severe financial stress. It’s the sort of thing that you find out after the fact, after the damage has been done. Let’s recap what’s been happening recently with the Federal Reserve and possible guidance changes:


  • They ended their taper in October, but maintained their guidance of rates low for a considerable period of time, but in speeches several governors, and key personnel have hinted that, with the current pace of employment growth, rates would have to rise in the near future. This could be the big announcement this evening – an end to the use of the phrase “considerable time”


  • There is a discrepancy in the interest rate path that the Federal Reserve anticipates compared to the market. The central bank expects rates to rise more quickly than the market does. That gap needs to close – there’s an orderly way to do this, and there’s a disorderly path, currently I fear the latter outcome seems more likely.


  • The Federal Reserve has made it clear that it views the collapse in oil prices as a permanent supply shock, which is at variance with the ECB. In this case, I have to side with the Federal Reserve, and most analysts would agree. Therefore the likely coming fall in inflation (because of lower pump prices) has to be viewed as a positive outcome with consumers gaining an effective tax cut. This is a positive for the US economy. It’s notable that the United States with a significant energy sector is likely to be a beneficiary on the consumer side, but will suffer the declining revenues (and employment) of high cost Shale gas producers who are forced to cut back. Europe has virtually no domestic energy production to speak of, so this should be an even greater benefit to the Eurozone economy.. but as I’ve said before, Mr Draghi has his own agenda.


  • Federal Reserve governors have hinted that the only thing holding them back from starting the normalisation process is the weak wage growth data that we’ve been seeing, but even they acknowledge that it’s hard to see this situation remaining as it is, with the unemployment rate edging towards 5%. Employees will be able to bid their wages up as tighter employment conditions become apparent, and the Federal Reserve will be keen to contain any resulting inflationary impact.


What does this mean for the US dollar? We have maintained for some time that the case for dollar strengthening is sound, and in the bigger picture we stick with that view. It is worth noting however that the recent price action and inter-market relationships indicate that the US dollar is sensitive to positive global growth. We see this when equities, and general risk sentiment is positive, the US dollar rallies, but the opposite happens when risk sentiment is bearish. But… but… I have to add the following recent observation… last night when equities collapsed into the New York close, the dollar sell off was muted in comparison with the move in equity prices. It’s just possible that there is a limit to how far the US dollar can fall in a negative risk scenario. Alternatively, it could just be that investors are reluctant to reduce their long dollar exposure with the FOMC announcement imminent. We will learn more about the inter-market relationships following this evenings events.


The Russian authorities have been intervening in the currency markets this morning, but with limited success. At the Russian roubles highest point this morning the USD/RUB rate went down to 62.20, as I write it’s back up to 68.90. This is a full blown battle now between the market and the Russian authorities, and I’m not sure it’s a battle the Russians can win. There’s blood in the water and the sharks aren’t circling any more, they are tearing chunks out of the economic prospects of President Putin’s Russia, and I don’t see a positive outcome. I don’t believe there’s been as much excitement in the macro world since the height of the Eurozone crisis. But one man’s excitement is another’s disaster. It really is a sobering situation, and we really must consider what remedies President Putin will seek to get Russia out of this financial disaster. I don’t need to tell you he isn’t an economist, it’s not clear to me that his solutions are going to be in that spirit.


Looking around at other Emerging market currencies, we appear to be in a period of consolidation after the frenetic activity of recent days. Consolidations are usually ended with continuations in the dominant direction (i.e., continued weakening), but I suspect that everything will remain on hold until after tonight’s announcement from Washington. As I’ve mentioned, the US dollar’s major partners appear to have hit the limits of their counter-trend rally. We see that in the likes of euro and Japanese yen some distance from their highs of the week. As with their Emerging market cousins, I suspect we’re in a holding pattern, but clearly the signs are pointing towards a continuation of US dollar strength.


We’ve seen UK average earnings data come out stronger than expected this morning. 1.6% for October, versus 1.2% previously, economists had forecast 1.5%. A few more months of data like this and Governor Carney might jettison his recent caution. We continue to believe that it is unlikely that we see UK rate hikes before the general election next summer, but we would not be surprised to see the Bank of England follow the big guys across the pond later in 2015. Unemployment data for the UK was also published with no change, which is mildly disappointing in comparison to the forecasts.. ah well! The other big data out this morning has been Eurozone CPI, which was in line with expectations, and the same as the previous 0.7% (core) outcome. On the face of it this aids Mr Draghi, but we see that the Bundesbank President his main rival on the ECB governing council is implacably opposed to Mr Draghi’s attempts to introduce quantitative easing, that’s a big battle that we should all be concerned about. This afternoon we will also see CPI data come out of the US – economists are forecasting no change at 1.8%. We shall see!

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