After 271,000 were jobs added in October, US unemployment rate fell to 5.0 percent. Meanwhile, average annual hourly earnings climbed by the most since 2009. As a result, the dollar strengthened and treasuries plunged. The report was a green light for the Fed’s chief Janet Yellen and her deputy Stanley Fisher, who recently held out the possibility of a December rate increase.
The US dollar and yields surged as the divergence meme, increasingly doubted, returned with a vengeance. The 271k rise in nonfarm payrolls was most this year. The 2.5% year-over-year increase in average hourly earnings is the most in six years.
Divergences in central bank policies continue to drive the global investment environment. This holds true not just across Developed Markets, but Emerging Markets as well. We thought it would be helpful to summarize our expectations of central bank policies going forward.
The US-German 2-year interest rate differential (swap rate) is a useful directional guide to the euro-dollar exchange rate. At about 105 bp, it is the highest since 2005. The US premium had peaked in late 2004 near 185 bp. In the second half of the 1990s, it was common for the US premium to be in excess of 250 bp. It has risen 25 bp since the middle of October, encouraged by Draghi, whose dovishness again surprised investors.
A critical driver in the foreign exchange market and the global capital markets more generally, is the continued preparation by the Federal Reserve for a rate hike, while many other central banks, including the ECB, warn investors that more accommodative monetary policy may be necessary. In the days ahead, the economic data and official speeches will occur in the context of building expectations.
The Federal Reserve is leaving low interest rates in place as it sees weak job growth and moderate economic improvement throughout America.
The decision by the Federal Open Market Committee comes a month after a previous decision to keep interest rates at historic lows despite broad expectations of a September interest rate hike. Expectations for a rate hike in October remained minimal, but the Fed’s comments on Wednesday afternoon encouraged a number of analysts and economists to predict a jump in rates in December.
When Australia’s Reserve Bank board meets on Melbourne Cup day next week, the question at hand is whether the RBA will seek to offset recent bank rate raises with a cut to the cash rate. With a cut, the hope is banks will then reverse their decision and get mortgage rates back to where we were before.
First Westpac, then Commonwealth Bank, now all of the big four have raised their variable home loan rates, purportedly in response to more stringent capital requirements imposed upon them.
The Reserve Bank of New Zealand and Sweden’s Riksbank can still surprise investors, but it is the BOJ and FOMC meetings that are the talk of the markets. Surveys suggest that around 40% of investors expect the BOJ to expand its asset purchases program this week. We are less convinced. Moreover, many real money clients spoken think the BOJ sticks with its current target of increase base money by JPY80 trillion a year. This raises the possibility that the surveys are not sufficiently up-to-date.
The European Central Bank and the People’s Bank of China reanimated divergence as a critical driver just when many observers had all but given up on it. The divergence is about monetary policy, broadly understood, not about the data per se. Of course, there is a relationship between the two but it may not be particularly tight.
ECB President Draghi sent an unambiguous signal to investors. Although the economic data from the region has been largely stable, the downside risks have grown, and the ECB will take action at its next meeting, which is in early December.
In the past, Draghi has indicated that the negative 20 bp deposit rate exhausted the scope for rate cuts. However, he did reveal that the possibility of another cut in the deposit rate was discussed. The key takeaway point is that the “degree of easing” would be re-examined at the December 3 meeting in its entirety.
