“The committee judges that the case for an increase in the federal fund’s rate has strengthened…” as per the Federal Open Market Committee (FOMC) statement. We are coming closer and closer for a federal funds rate increase as predictions look for a 66% December lift off and November as live meeting according to federal officials. Madam Yellen and the team will not have much of a choice as the USA economy growth is solid and in a good position for a hike.
NFP (Non -Farmer Payroll) which is one of the key objectives had a solid outcome in October 2016. As the days of 200k job gain per month slowly diminish as labour markets produce thousands and thousands of jobs over the last few years. Although unemployment ticked higher to 5% from 4.9%. It is a good sign for the US labour market as they are battling with an aging population. In economic terms when jobs get created at a rapid pace like in the US economy, normally salaries per hour increase as the job market is more fertile. Currently, maximum employment becomes more a reality and investors shift their balance to average earnings per hour.
The average earnings normally increases when unemployment decreases and decreases when unemployment is high. Wages per hour rate is extremely important for the domestic-driven economy like the USA, where retail sales contribute 60% of total GDP. Retail sales were and still is very strong and keeps US economy on course for a rate hike in the near-term, but it’s all thanks to lower federal funds rates. Retail sales are the bread basket of the USA economy and earnings play a massive role to hold spending up. Average earnings are currently 2.80% higher than the long-term annualised growth rate of 2.40% and hour earnings are up 25.79 up from last month 25.73%.
Average earnings and credit consumer help tremendously with the federal reserve inflation goals only when jobs number is high. With higher jobs and salaries advancement normally inflation increases. When people are earning more, the credit increases, which leads to high spending and eventually inflation picks up that the federal reserve desperately needs. Yes, inflation pressures like low energy prices and non-energy imports are still a concern for Yellen but with strong job numbers and accelerating earnings it put her in a good space compare to other central banks.
If we do compare the USA economy to other developed economies like Europe, Australia, New Zealand, Britain, and Japan it is like day and night. European Central Bank’s (ECB) Mario Draghi battled with inflation and needs a lower Euro to spear on growth. The Bank of England (BOE) sits in a real mess, Brexit derailed Mark Carney’s plans for an increase in rates as inflation is nowhere near 2%. Mark Carney made it clear that the more asset repurchases and lower rates are needed to help Britain for the soft exit. A lower Sterling may help with restructuring of its economy but how low will they go? Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand (RBNZ) complained of over valued currencies as it can complicate their respective economies. Inflation in these nations battles along, due to lower quality borrowers, lower wages and sluggish household spending. How long Japan’s economy will survive, no one knows, as BOJ runs out of tools to increase inflation. Investors lose hope on Kuroda and team to meet inflation goals, it surely an illusion to see Japan on a 2% inflation.
With all these uncertainties above, I should mention that it is very rare that we will experience a weaker dollar. Historically, the performance of the dollar against a basket of currencies normally sits in October at around 96-98. Currently, it sits just over 96 marks. A strong for October looks more likely as reality as economic data looks solid, unless US election tension grows.
- China reported lower than expected September reserve figures.
- Polish central bank Governor Glapinski adjusted the forward guidance.
- Brazil will open up development of its so-called pre-salt oil fields to foreign companies.
- Colombia’s referendum on the FARC peace agreement failed by a razor-thin 50.2% to 49.8% margin.
In the EM equity space as measured by MSCI, (+5.3%), (+4.4%), and (+3.0%) have outperformed this week, while (-3.3%), UAE (-2.2%), and (-1.4%) have underperformed. To put this in better context, rose 1.4% this week while fell -0.7%.
In the EM local currency bond space, (10-year yield -23 bp), (-8 bp), and (-4 bp) have outperformed this week, while the (10-year yield +38 bp), (+19 bp), and (+11 bp) have underperformed. To put this in better context, the yield rose 14 bp this week to 1.73%.
In the EM FX space, (+1.7% vs. USD), (+1.4% vs. EUR), and (+1.3% vs. USD) have outperformed this week, while (-1.5% vs. USD), (-1.3% vs. USD), and (-1.3% vs. USD) have underperformed.
Although Chinese markets are still closed for the national holiday, lower than expected September were reported. They fell to $3.166 trillion from $3.185 trillion. This is a new five-year low. This was also a somewhat larger drawdown than surveys anticipated, which when coupled with the softening suggests that capital outflows from China may be picking up again.
Polish central bank Governor Glapinski said he expects the next move to be a hike, but adjusted the forward guidance. He now sees the likely start of the tightening cycle in early 2018 instead of late 2017. Deflation appears to be easing, while the economy rebounded in August after a weak July.
Brazil will open up development of its so-called pre-salt fields to foreign companies. Congress approved legislation that ended the requirement that Petrobras (NYSE:) be the sole operator in these deep-water areas by a 292-101 vote. Amendments to the legislation will reportedly be debated next week before President Temer signs it into law. With oil prices rebounding, the timing is good for Brazil to try to lure foreign investors into the sector.
Colombia’s referendum on the FARC peace agreement failed by a razor-thin 50.2% to 49.8% margin. Polls had suggested a fairly easy passage, but the “no” vote was driven by the perception that the deal was too lenient on the rebels. Both sides are signaling a desire to continue the peace process, but we do not think a renegotiated deal will be easy. If the government comes back with a tougher deal on FARC, the rebel leader will be hard-pressed to give in. President Santos was just awarded the Nobel Peace Prize.
How to make profitable trades today?
Trades, braced on major financial events today. Today we will learn about several important figures of the Eurozone, on a day in which the EU finance ministers have a meeting. It should be said the importance of Eurozone ministers and government policies is becoming increasingly irrelevant – governments just go on doing what they have been doing, leaving the main decisions that affect market prices to be made by central banks.
After learning last week that the Eurozone economy is even weaker than what was expected, today’s figures should only confirm its anemia. This is bearish for the EUR, which, since the beginning of May, has been sharply losing ground against the USD. This is in line with the predictions of Ridge Capital Markets, where we have been bullish on the USD all along.
We still believe that a long position should continue making a profitable trade for investors. Financial and currency markets are seeing again the USD rising (something which we have always expected), with the DXY staying comfortably above 95 points and inching upwards – after a short and not overly dramatic correction. Long-term, we see the DXY reaching 100 points.
This ties in to the statements by FOMC members in the recent days. Several Fed members have been making consecutive statements about how expectable a rate hike in June should be. Essentially, we believe that, as markets have been tremendously complacent about the Fed and its lately perceived dovish policy, Fed members are trying to get traders less complacent, and the market a bit less confident on bullish views.
Today we will hear more statements of Fed members, which we believe will probably stay on this hawkish page, but, at the end of the day, it is the ‘Yellen word’ that traders should pay more attention to.
At Ridge Capital Markets, we consider more likely for the Fed to possibly raise rates in July, since doing so in the middle of June, a week before the UK “Brexit/Bremain” referendum, could send too heavy waves of shock that Yellen would hardly want to start.
Still, for now we believe that the DXY is a good play, that going long USD/EUR is a trade that should go on paying off, and that Gold should stay correcting down to the $1,200 frontier, pressured by the USD – so a very short-term Gold short may also be a trader opportunity not to be missed (we say this while being very bullish in a long-term outlook).
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