Originally published by Rivkin
Overnight we had the release of the minutes from the FOMC’s September 20-21st monetary policy decision that confirmed market expectations that it is highly likely we will see a rate hike at the December meeting. Vice chair Stanley Fischer recently described the decision in an interview as a “close call” and the minutes support those comments. The minutes show that several participants stated that the decision at the meeting was also a close call and that a “substantial majority now viewed the near-term risks to the economic outlook as roughly balanced”
While there has been progress towards the committees 2% inflation target as well as increased upward pressure on wages “most of these participants thought it would be appropriate to await further evidence of continued progress”. The two months between now and the December meeting should provide ample time for this further evidence to be confirmed.
The FOMC remains data dependent and that economic conditions would evolve in a manner that would only warrant gradual increases in interest rates. This is further highlighted in the minutes that “it would be appropriate to raise the target range for the federal funds rate relatively soon if the labour market continued to improve”. While the September non-farm payroll data was below forecasts adding 156,000 new jobs, consistent readings above 100,000 are enough to keep the unemployment rate stable around 5% when factoring in population growth.
The committee noted that a “reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labour market and inflation”. This statement is very logical, after all the Fed has the ability to raise interest rates if necessary but only limited scope to reduce them. Importantly members also expressed concern about potential adverse effects on the credibility of the committee if they were to postpone reducing accommodation further. At this point they have prepared the market to expect a December rate hike and postponing this without a significant reason could severely damage market confidence.
Overall these minutes confirm what the market expects, that pending any significantly adverse data the FOMC will raise rates by the end of the year. We have two more meetings, in November and December, logically raising rates in November wouldn’t make any sense. Firstly December gives further time to see evidence of progress in the underlying data, the November meeting is just prior to the U.S. presidential election and there is no need to add to any uncertainty around this, the recent data does not suggest any urgent action is required that cannot wait an additional month. The December meeting will also include updated economic projections and a press conference by Janet Yellen allowing her to explain the decision. Finally the market is currently pricing November as a less than 20% probability while December is roughly 70%, it would be completely illogical to shock the market by hiking in November.
There was no significant reaction in financial markets given there were no surprises in the minutes, the U.S. dollar strengthened modestly, up +0.25% against a basket of its peers. The yield on two-year debt was little changed around +0.8625% while the yield on ten-year debt which is more sensitive to rate changes increased 1 basis point to +1.7709%. Equity markets were flat, both the S&P 500 & Nasdaq 100 up +0.11% & -0.05% respectively. Gains on the S&P500 were led by utilities (+0.98%) and telecommunications (+0.46%) while healthcare (-0.54%) and energy (-0.42%) lagged behind.
Across to Europe it was another quiet night for data releases with the only significant release being the Euro-zone industrial production (YoY Aug) which surpassed expectations of 1.0% with an actual reading of +1.8%. The EUR/USD extended a three day decline falling a further -0.36% with equity markets also lower, the Euro Stoxx 600 & DAX finishing trading -0.47% & -0.51% weaker respectively. The benchmark for sovereign debt, German Bunds declined with the yield on two-year securities rising +1.7 basis points to -0.653% as did the ten-year yield, up +4.4 basis points to +0.067%.
In the U.K. the GBP/USD rose +0.86% against the U.S. dollar as Prime Minister Theresa May said she would give parliament every opportunity to debate her plans for withdrawing from the European Union. The Pound did close off its session highs though as May ruled out allowing a vote on triggering a formal Brexit procedure. The first chart below shows the Pound & Euro against the U.S. dollar, both of which are significantly weighed on by political uncertainty surrounding Brexit negotiations that should keep any upside fairly limited. U.K. bond yields rose as investors continue to demand a higher return as a result of the political uncertainty, two-year yields gained +. Basis points to +0.22% as did ten-year yields up +6.5 basis points to +1.044%. Both the FTSE100 & 250 finished trading lower, down -0.66% & -0.65% respectively.
Locally the Australian dollar finished +0.44% higher on Wednesday following an improved reading in the Westpac consumer confidence survey (MoM Oct) increasing to 1.1% from 0.3% previously. The S&P/ASX 200 pared initial losses to close relatively flat, down just -0.09% and we can expect a weaker start to trading this morning with ASX SPI200 futures down 15 points.
Data releases:
- U.K. House Price Index (MoM Sep) 10:00am AEDT
- Australian Consumer Inflation Expectations (MoM Oct) 11:00am AEDT
- German CPI (YoY Sep) 5:00pm AEDT
- Canadian House Price Index (YoY Aug) 11:30pm AEDT
- U.S. Continuing & Initial Jobless Claims Oct 1 & 8) 11:30pm AEDT
- U.S. Crude Oil Inventories (Oct 7) 2:00am AEDT
- Fed’s Harker Speaks on Economic Outlook 3:15am AEDT
This article was written by James Woods - Global Investment Analyst, Rivkin Securities Pty Ltd.