HomeContributorsFundamental AnalysisSoft US CPI Wrong-Foots USD Longs ahead of Fed

Soft US CPI Wrong-Foots USD Longs ahead of Fed

  • European equity markets lose slightly ground today. US equities futures traded in negative territory as Republicans saw their majority in the Senate reduced to the smallest margin. However sentiment improved again throughout the session. Major US indices opened with gains of 0.2% to 0.4%. S&P and Dow touch new all-time peaks.
  • US inflation picked up in November thanks to a jump in energy prices (0.4% M/M & 2.2% Y/Y) yet unexpectedly cooled when excluding food and fuel costs (0.1% M/M & 1.7% Y/Y), which could factor into Federal Reserve discussions this week on how fast to raise interest rates.
  • Italian newspaper Messagero reported that the parliamentary vote is scheduled on March 4 and President Mattarella is expected to dissolve parliament on Dec 28 or Dec 29. Based on current polls, the Five Star Movement has an edge over the Pd for first place, but a centre-right coalition could eclipse them both.
  • Industrial production in the euro area grew by 3.7% in the year to October after a 0.2% rise on the month. Ireland led the pack for the year, with a rise of 13.4%, while the Netherlands bumped along the bottom with a decline of 0.4%.
  • The number of people in work in Britain fell again (-56k), suggesting employers are turning more cautious as Brexit nears. Pay growth quickened slightly (2.3% Y/Y) but it remained lower than inflation. The unemployment rate stabilized at 4.3%.
  • The European Parliament urged EU leaders to allow the next phase of EU negotiations to start, backing a motion that recognised that Brexit talks had made sufficient progress-. The motion also included a line criticising Britain’s Brexit negotiator Davis.

Rates

Limited short covering after US core CPI miss

Global core bonds currently trade mixed with US Treasuries outperforming German Bunds. Both faced selling pressure at the start of European trading with the Bund being worst off. Technical factors might have been at play as the German 10-yr yield finally bounced off 0.3% support yesterday following an intense, multiday, test. A (small) negative surprise in US core inflation readings convinced some investors to do some last minute short covering ahead of tonight’s Fed meeting and caused a U-turn in trading dynamics. US Treasuries record small daily gains at the moment, while the Bund is near opening levels. Stronger than expected, but outdated, EMU industrial production data left no traces.

At the time of writing, the US yield curve drops 1.6 bps (2-yr) to 2.2 bps (5-yr) lower. Changes on the German yield curve vary between -0.7 bps (2-yr) and +0.2 bps (30-yr). On intra-EMU bond markets, 10-yr yield spread changes versus Germany widen up to 4 bps with Italy (+7 bps) underperforming and Greece outperforming (-9 bps). The Italian underperformance could be partly due to the starting shot in the parliamentary campaign. Media reported that early parliamentary election will be held on March 4.

The Fed meets today and is expected to hike its policy rate a third time this year by 25 bps to 1.25%-1.5% which is completely discounted in markets. The new "dot plot" will receive most attention. We expect the central bank to stick to its intention to hike rates three times next year. Since September, (rate) markets for the first time this hiking cycle started aligning with the Fed’s scenario. Past years, they were positioned much more dovish which proved right in 2015 and 2016. The market implied probability of a next rate hike (to 1.5%-1.75%) in March already stands at 60% with two hikes discounted for 2018. The median rate projection for 2019 has more potential to change. In September, it was 2.688% with 8 governors expecting higher rates and 8 governors expecting lower rates. A small upward shift is possible if governors start factoring in some positive effects from fiscal stimulus. The median growth forecast for next year (2.1%) could also be subject to an upward revision. The impressive sell-off at the front end of the yield curve suggests that some short term profit taking is possible while immediate losses at the longer end of the curve seem more likely given current positioning. In that case, we might see some corrective steepening short term.

Currencies

Soft US CPI wrong-foots USD longs ahead of Fed

The dollar was driven by alternating feelings throughout the day. Initially the greenback held op fairly well even as the Republican party saw its majority in the Senate reduced to the smallest margin. In US dealings, the core US CPI came out slightly softer than expected. US yields declined several basis points, wrong-footing USD longs. EUR/USD trades in the 1.1760 area. USD/JPY tries to hold north of 113. Will the Fed’s message be able to change fortunes again in favour of the dollar?

Asian equities opened mixed, but found a better bid later. Most indices ex-Japan and India closed in positive territory. Japan core October machine orders were strong (5.0% M/M), but didn’t help Japanese equities. They underperform as USD/JPY declined. The US currency was in the defensive as the Republican party lost the Senate vote in Alabama, reducing its majority in the Senate to a slim 51-49. USD/JPY spiked to the 113.15 area but returned to the 113.40 at the start in Europe. EUR/USD rebounded overnight, trading in the 1.1750/60 area at the European open.

European equities opened with slight losses, but tried to join the Asian positive momentum. However, there was no strong enough driver to support a clear directional move. European investors were maybe a bit uncertain on the consequences of the very narrow majority that the Trump administration will have to cope with going forward. Even so, core yields traded with a slight upward bias as investors counted down to the Fed’s policy decision. The dollar remained well bid against the euro but struggled against the yen.

The US CPI report was slightly softer than expected. US November headline inflation rose 0.4% M/M and 2.2% Y/Y (from 2.0%) as expected, but core inflation unexpectedly softened from 1.8% to 1.7%. As such, the miss wasn’t that big. However, over the previous days investors gradually adapted positions preparing for a rather hawkish Fed. This build-up became stretched/vulnerable after the softer core inflation. US yields declined up to 5 bps. USD longs were wrong-footed by this unexpected loss of interest rate support. EUR/USD jumped higher in the 1.17 big figure. The pair trades in the 1.1760 area. USD/JPY filled bids just below 113 (currently 113.05). Will the Fed still be able/try to convince markets not to give too much weight to ongoing mediocre inflation data?

Sterling going nowhere. Data give no clear signal

Sterling opened near yesterday’s closing levels with EUR/GBP hovering in the 0.8810/20 area. During the morning session, EU’s Barnier defended the recommendation to start the second phase of Brexit negotiations before the EU parliament. He warned that the UK should meets its promises, but the tone was less tough than was the case earlier this week. The EU Parliament finally approved a Brexit resolution. Sterling gained a few ticks during the morning session. The UK labour data were mixed. UK employment dropped a bigger than expected 56k in the 3 months to October. At the same time, UK wage growth was marginally higher than expected (2.3% ex bonuses). Sterling hardly reacted as the report contained little news for the BoE to change its assessment. However, the gains of sterling remained limited as the UK government continues to face headwinds in the parliamentary vote of the UK Brexit bill (also from conservatives PM’s). EUR/GBP holds near the 0.88 pivot. Cable rebounded to the 1.3360 area, mostly on post-CPI USD weakness.

KBC Bank
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This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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