Yesterday’s equity rally on the back of the news that Larry Summers had withdrawn his name for consideration in the hunt for the next Fed Chairman fizzled late in the day, with the subdued performance then carrying over to the overnight session. Unable to generate any further momentum, the Nikkei dropped by 0.65% while the Shanghai Comp lopped 2.05% off of its valuation by the time the Asian trading session had come to a close.
The Aussie was on a steady upwards climb against the USD overnight, finding bids as the monetary policy minutes from the RBA meeting at the beginning of September echoed a slightly more hawkish tone than we’ve seen from the Central Bank over the last year. The combination of historically low lending rates and the subsequent drop in the exchange rate have aided in providing substantial policy stimulus to the economy, the effects of which the bank feels will continue to flow-through to the economy. Consequently, the RBA judged interest rates were fine at their current levels, while also deciding to strike a more neutral tone that didn’t prescribe imminent rate cuts or hikes. AUDUSD grinded higher after the minutes, ebbing its way into the mid-93s.
European equities are similarly having a hard time generating buying interest midway throughout their session, as the FTSE, Dax, and Stoxx are down by 0.43%, 0.20%, and 0.29% respectively. The subdued equity performance is despite some better than expected economic data, which saw German investor confidence rise to a three-year high this morning. The survey compiled by the ZEW institute showed the reading on economic sentiment increased to 49.6 in September, better than the 42.0 registered in August and stronger than the median forecast of 46.0. The improved outlook that the Germany economy is gaining momentum bodes well for the EZ, and favourable in terms of progress in the economic recovery for the common-currency bloc. The EUR is on stronger ground against the big dollar this morning, up 0.3% at the time of writing to trade into the mid-1.33s.
As we get set for the North American open, a couple key pieces of economic data just hit the wires. Consumer prices for the American economy over the month of August came in a little softer than expected, increasing by 0.1% last month and just 1.5% when compared to 12 months prior. Economists had been forecasting prices would increase by 0.2% over the prior month, while at a pace of 1.6% from a year ago, which confirms that pricing pressure towards the consumer still remains subdued and anchored firmly below the Fed’s target. While unlikely the Fed alters their course for monetary policy based on this number, it does make it harder to see the Fed getting more aggressive than what markets have come to expect as “taper-lite” tomorrow.
Also out this morning, manufacturing sales for Canada in the month of July saw an increase of 1.7% from the prior month, better than expectations of 0.5%. Although we did see a small knee-jerk reaction to the soft CPI number and strong manufacturing sales data, the Loonie wasn’t much changed after the release, but still stronger against its dollar counterpart as the USDCAD creeps back into the low 1.03s ahead of the FOMC. US equity futures are pivoting close to unchanged before the opening bell, with investors currently looking content to position square ahead of tomorrow’s big release. Hydrocarbons continue to unwind after yesterday’s sell-off, with front-month WTI seeing bids hit to trade down to $106/barrel.
Looking forward to tomorrow, the main event everyone will be waiting for is the Federal Reserve’s interest rate statement and their updated economic projections. The majority of market participants are expecting the Fed to reduce their monthly balance sheet in the neighbourhood of $10-15bn per month, and with the slight slowdown in in housing market activity and soft jobs numbers for the last couple of months, it is hard to envision the Fed deciding to go ahead with anything more aggressive than what the market is currently expecting. If indeed the Fed goes ahead with a small taper and reinforces the notion its communication has been effective as the majority of market participants are anticipating the taper, the Fed faces another challenge in its forward guidance, which may very well steal the show on Wednesday. The issue lies in the fact that the Fed is set to release its economic forecasts for 2016 on Wednesday, and if the Fed envisions the economy to be moving along the same path as in June, it is likely those forecasts project both the unemployment and inflation rate moving towards more normalized conditions. If this is indeed the case, a normalization of interest rates should be expected throughout 2016, which could be tight with officials expecting the overnight rate to be 1% at the end of 2015, and a neutral Fed funds rate to be in the neighbourhood of 4%. The inconsistency in communication will either be placed on the Fed’s economic projections not unfolding as quickly as expected, or the Fed runs the risk of negating its forward guidance pledge that the raising of interest rates will be a slow and gradual process.
Make sure to speak to your dealing teams about strategy heading into Wednesday, as less tapering from the Fed or downgraded economic projections will put pressure on the dollar and lift high-yielding currencies, while a larger taper announcement (> $20bn) will boost the USD and cause a sell-off in Treasuries.