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The market has not changed its mind. Following Brainard's comments yesterday the market had downgraded the chances, which were already modest, of a Fed hike next week. The September Fed funds futures is unchanged on the day. The implied yield of 41 bp matches the 50-day moving average.
Our approach to Fed-watching is clear: Among the cacophony of voices, the Troika of Fed leadership, Yellen, Fischer and Dudley provide the clearest signal. They are most often on message, and their comments have been the best indications of policy.
Remember at the end of last summer; Dudley said a rate hike was less compelling. This foretold the lack of hike last September. Earlier this year, as several regional presidents were talking up a rate hike, Yellen pushed against it.
Stocks and bonds have begun the new week much like last week ended. Sharp losses are being recorded. The US dollar is mixed, with minor losses against the euro, yen, and sterling, but a firmer tone is evident against the dollar-bloc and emerging market currencies.
EM ended last week on a soft note. Perhaps it was the North Korean nuclear test (see below). Perhaps it was disappointment in the ECB or rising Fed tightening odds. Whatever the trigger was, EM FX weakness persisted and appears likely to carry over into this week.
Indeed, as the September 21 FOMC meeting approaches, markets are likely to get even more jittery and choppy. Just to keep things in perspective, after Friday's drop, SPX has retraced less than 38% of the big post-Brexit bounce and so this correction in “risk” could go on for a bit longer.
The week ahead will likely be shaped by a combination of what happened last week and what will happen the week after next. The end of last week saw a sell-off in equities and bonds and a recovery in the US dollar. The week after next the FOMC and BOJ meet in apparently live meetings, meaning that policies may be adjusted.
Over the summer, the US dollar was out of favor with the speculators in the futures market. This means that gross long positions increased and gross short positions tended to fall. Speculators are only short three of the eight currency futures we track, the euro, sterling and Mexican peso.
It took the market a few days to overcome the shockingly poor non-manufacturing ISM (51.4 vs. 55.5). However, by the end of the week, the US dollar bulls had regained the upper end. The September Fed funds was implying a yield of 41.75 bp, up a quarter of a basis point from the September 2 close.
In the EM equity space as measured by MSCI, Colombia (+4.1%), Hong Kong (+3.9%), and China (+3.6%) have outperformed this week, while Thailand (-4.4%), Qatar (-3.3%), and the Philippines (-2.7%) have underperformed. To put this in better context, MSCI EM rose 1.2% this week while MSCI DM fell -0.5%.
The US dollar is lower against all the major currencies this week as North American participants close it out. On the day, the dollar is consolidating swings yesterday and is narrowly mixed. Bond yields are higher and equities are mostly lower.
The euro has finished lower the last three Fridays. The streak may end today. The euro has found support nearly $1.1260, and the intraday technicals favor a move higher in the US morning.
The shaving of 2017 and 2018 growth forecasts, recognition of continued downside risks did not prompt the ECB to adjust monetary policy. Rates were left unchanged, as widely expected. The ECB also refrained from extending the asset purchases. This is somewhat disappointing. It was the only action that investors were discussing as a possibility. Bond yields appear to be backing up in response.
The pessimists have claimed that the US is generating low paying jobs. Nearly every monthly jobs report is followed by what seems to be a canned retort. The media picks up on the story and continues to regenerate it. Earlier in the recovery, the argument made sense. It makes less sense now.
Disappointing industrial output figures from Germany and UK are helping stabilize the US dollar after yesterday's shellacking. Investors have been fickle about the prospects for a rate hike this month, and the unexpected dramatic slide in the service spurred a downgrading of such expectations, and a flight out of the dollar. It was not simply a quest for yields, though that was part of it. Surely, the yen and euro's strength is not a function of superior yields than the US.