What started out as a rather quiet early morning session, quickly turned ugly for equities after Federal Reserve speakers threw cold water on the party and warned that investors were expecting too much from monetary policy. Philadelphia Fed President Plosser opined that a rate hike from the FOMC might come sooner than expected, as he see significant improvement in the labour market and housing fundamentals remain strong, which spooked investors and caused the initial sell-off in equities. The President of the New York Fed, Bill Dudley, was on the speaking circuit yesterday as well, and cautioned that the equilibrium real interest rate might be lower than historic norms, which increased the offer-tone for stocks as bond yields tumbled with investors increasing their exposure to fixed income.
After the dust settled there was a late-day ramp that brought the S&P off its earlier lows, but the index still finished the day off by 0.65% as the closing bell was rung. Yields on the 10-year US treasury were hammered lower over the course of yesterday’s session, but managed to hold above the psychologically important 2.5% level. The USD gained some ground on the back of Plosser’s comments a rate hike might be coming sooner rather than expected, but with USDJPY clinging to its 200-day moving average in the low 101s on the flight to safety trade, the DXY finished the day essentially unchanged.
The Yen was in the spotlight during the Asian session, with traders pushing USDJPY to a three month low and below the all-important 200 day moving average after the Bank of Japan decided to leave monetary policy unchanged and offered a more upbeat assessment on the Japanese economy. Kuroda and the BoJ remained confident that the economy would rebound from the temporary slowdown in growth caused by last month’s sales tax hike, while also revising up their forecasts for capital spending from businesses. The statement explaining the BoJ’s rationale for deciding to leave policy unchanged also dashed hopes of any near-term additional quantitative easing, as the central bank removed a key phrase about the region being in a deflationary state, showing policymakers are confident about meeting their inflation target of 2% without any additional stimulus. While Kuroda did try and talk down the Yen at his press conference by saying he saw no reason for the currency to rise considering the BoJ was maintaining their accommodating stance while the Fed looks to wind down its asset purchases, traders weren’t buying the jawboning, increasing their exposure to the Yen which sent USDJPY to a test of the 101 handle. With the repricing of expectations for when the BoJ might look to add to its stimulus program being pushed further out, it is likely the Yen shorts will continue to be frustrated, and it could be until the 100 mark where new short Yen positions begin to build.
Keeping with central bank news, the minutes and voting breakdown from the Bank of England’s early May policy meeting were released this morning, showing that the decision to keep rates unchanged and the asset purchase facility stable was a unanimous. While the Monetary Policy Committee members were all on the same page as to the optimal path of policy, the discussion surrounding the decision produced minutes that had a slightly hawkish tinge to the them. Although it appears the MPC is getting more comfortable with the prospect of raising rates, the members all agreed there needed to be more progress in the spare economic capacity, and that the potential for buildup of financial imbalances in the housing market would be first be addressed by the FPC, with monetary policy as a “last line of defense.” That being said, the minutes also reinforced the idea that to sustain a gradual rising of rates, the first rate rise might be earlier than expected; a hint that the central bank is starting to more seriously think about tightening policy.
In addition to the minutes from the last BoE monetary policy decision, retail sales for the month of April were released, with the headline reading blowing expectations out of the water with a 1.3% increase from March. Expectations had been to see the reading increase by 0.5% on a m/o/m basis, and after stripping out the more volatile fuel prices, the core reading shot up by 1.8%. The big contributors to the strong consumer demand to start Q2 were driven by household items and discounts on food, and the y/o/y increase was the largest seen since May of 2004. The strong retail sales numbers and the slightly hawkish BoE minutes propelled GBPUSD to the low 1.69s before Sterling buying pressure eased; and while Cable has ebbed back to just below the 1.69 handle was we go to print, it seems as if the test of 1.70 is only a matter of time.
Heading into the North American open, the mixed performance of global equities (Nikkei down by 0.24% on BoJ disappointment, Dax up by 0.27%) and lack of tier-one economic data west of the Atlantic Ocean has equity futures slightly higher after yesterday’s wash-out has some investors in bargain-hunting mode. Front-month WTI has broken above $103/barrel, but has been of little help to the commodity-currency bloc that is weaker against the big dollar. USDCAD is essentially unchanged from yesterday as we get set for the opening bell, unable to break away from the 1.09 level that seems to have the pair magnetized for the time being.
The remainder of the North American session will once again be dominated by Fed speak, as both Yellen and Kockerlakota have engagements later today, capped off with the release of the minutes from the last FOMC meeting where the Fed decided to pare back another $10bn in monthly bond purchases. The meeting itself was relatively uneventful as there was no updated economic projections, no press conference from Yellen, and the taper continued on what appears to be autopilot, yet the minutes could provide some additional insight into how the discussions surrounding an exit strategy for the Fed could be developing
While comments from Fed officials (and an ex-chairman) suggest there is no need to begin passively shrinking their balance sheet prior to raising rates, should the minutes reveal there was a discussion around utilizing reverse repos to proactively drain excess liquidity from the system in an effort to normalize policy ahead of raising rates, the hawkish commentary could give the USD another lift. Alternatively, if the minutes showed a good portion of the meeting was spend defining slack in the labour market and how that will affect the evolution of forward guidance, a dovish outlook towards wage growth and full vs. part-time employment could bolster risk-appetite and have traders dumping USD in favour of higher yielding assets.
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