The main event today is the ECB meeting. Many observers expect a dovish tilt as Draghi prepares to expand QE in December. A Bloomberg survey conducted last week found that 80% of economists expect the ECB to eventually do so, with 56% expecting it at the December 3 meeting. The survey found 86% expect a move by the end of Q1 2016. Every central bank that has tried QE has had to do more than initially anticipated.
Japan’s trade balance was worse than expected in September. It posted a JPY114.
Bloomberg created a function that claims to give the odds of a Fed move by interpolating from the Fed funds futures and options contracts. It is widely used, but I remain a skeptic.
The main thrust of our bullish US dollar outlook is the divergence in monetary policy trajectories. We do not think the divergence has peaked and anticipate it to persist through next year and into 2017.
The Fed’s Chair seemed to have surprised the market with her comments after North American markets closed yesterday. She reiterated what the Fed said last week. It is still on the path to hike rates before the end of the year, barring a significant economic surprise. She did put the concerns about the global environment in a larger perspective, suggesting that, based on current information, if does not look like developments abroad will have a material impact on policy.
The US dollar is trading heavier after extending its post-FOMC gains that saw the euro and sterling record two-week lows yesterday. The euro extended its recovery that was marked by yesterday’s outside session. Its gains have stalled in front of the 20-day moving average (~$1.1235) and the first retracement objective of its decline since last Thursday.
The Federal Reserve threw investors a curve ball last week. Until then, Fed officials have shown a clear preference for survey-based measures of inflation expectations. Last week, seemingly out of the blue, that Fed made reference to market-based measures of inflation expectations. It implied that the decline in the break-evens (difference between conventional and inflation-linked bond yields) got officials’ attention.
The US dollar started softer in Asia, where Japan is on holiday for the first half of the week, but has come back bid in Europe. The key issues now seem to revolve around intentions and implementations. Those are the key unknowns.
Intentions refer to the major central banks. Three Fed officials spoke over the weekend. Williams, Ballard, and Lacker (who dissented) all said a hike before the end of the year may, still be appropriate. US interest rates are a couple basis points firmer today.
The Federal Reserve left the Fed funds target at 0-25 bp. It recognized continued improvement in the US economy but raised the level of concern over international developments.
Markets have been speculating for months about whether the US Federal Reserve would raise interest rates in September. The day has finally arrived, and interestingly, there’s much less certainty now about which way it will go than there was just a few weeks earlier.
In August, more than three-quarters of economists surveyed by Bloomberg expected a rate hike this month. Now, only about half do. Traders were also more certain back then, putting the odds at about 50-50. Now the likelihood of a rate hike based on Fed Funds Futures is about one in four.
