With congressmen in the US splitting from the party lines in another vote for the Healthcare bill, republicans are having a hard time remaining united, and the markets are starting to notice. The dollar dropped on the news that the republicans ability to pass the new healthcare bill is waning and the dollar index is suffering as a result.
The inability of the US government to pass bills or show signs of cooperation have the world taking notice and looking for better regions and currencies to place their money. The talk by the Fed and their concerns on inflation has contrasted other central bank's hawkish outlooks and started the dollar decline. We could now see an acceleration as the much anticipates (and baked in) prospects of fiscal policy padding the withdrawal of monetary policy looks less likely.
Today the Bank of Canada (BOC) is likely to raise its benchmark interest rates by 25 basis points. Many are looking at the language as the true determinate of the direction of the Canadian stock markets, bonds, and the dollar (CAD). The current rate hike has been priced in but markets are going to look for a conciliatory tone in the report that will determine how likely further hikes are to be. Many of these worried are around the high debt levels in the Canadian economy, some estimates around 170% of GDP. The central bank is likely to say further hikes are 'data dependent' and not have as aggressive of a tone as some fear. The board should look to see if the slowing economy is accelerated by this first hike before looking to adjust policy further. In terms of seeing how this will affect the private consumers one has to just watch the performance of the large banks.
Many of the banks have outrun the overall market in the anticipation of greater profitability in a rising rate environment. That performance can quickly change if we start to see loan delinquencies and a slowdown in lending as a result of these higher rates. A quarter basis point increase should not be the tipping point of the entire lending economy in Canada but how the bank react to the longer term prospects of more increases, especially in their management of in house prime rates on mortgages, will be the deciding factor.
Over the past 24 hours the Euro has hit a year high, the markets saw a drop in value (especially in tech), and volatility in most asset classes spiked. It was a very central bank heavy day but there seemed to be something more to the movements in assets.
Mario Draghi of the ECB came out more hawkish than expected which resulted in many investors taking notice and adjusting their assessments of the Euro. There could also be a larger trend that could be starting to take form. The ECB is yet another major central bank that is now taking away the punch bowl of easy monetary policy, and much sooner than the markets were expecting based on the shockwaves. Over time the markets will have to find the best places to invest based on fiscal policy and unassisted economic growth. This trend makes sense with the selloff in tech stocks as a lot of cheaper money was chasing growth.
The Dollar rally from the Fed's moves to raise rates and discuss balance sheet reduction could be coming to an end. The Eurozone is in an earlier stage in the growth cycle than the US and already looking at the potential for less stimulus. With US growth starting to wane from being in a later stage of the cycle, the ability for rates, and the Euro, to move up in relation the Dollar.
These are one day moves and could be reverted with any news confirming the former trend but it is important to be aware of these trends and look for confirmations, flaws, and adjustments.
After the record setting highs of the US markets last week, the futures look to be closing the gap to start this week on a positive note as well. This has the VIX index back near multi year lows. Couple this with a light week in terms of US economic news and you have the markets at the whims of politics. With more news sure to come out from the repeal of Obamacare, and talks of an ambitious tax plan to follow, it will be interesting to get the market's likelihood of a meaningful deal.
The lack of greater economic news will provide a clearer link to the talks of a revised tax deal and the removal of Obamacare legislation to how much the market is still pricing assets to a deal. Political exhaustion will come at some point, but as seen in the VIX it looks like strong economic news may take over as a driver in the near term. one thing that investors can be sure of is that low volatility makes bets on larger swings in asset prices less expensive to hedge against. Not a bad idea given the conditions.
Crude oil has been struggling to maintain its gains since the start of the year, nearing the lows that it has seen in early March. The rise we have seen in oil was from the OPEC members (and others) agreeing to output cuts to shore up prices. This has faded over time as inventory levels started to creep back up, but not all of this is to blame on the Cartels.
The US onshore producers have increased production with the rise in oil prices making many of their fields profitable again. This spike in production can stop almost as easy as it started. Longer term, many oil companies are locking in contracts for oil, sacrificing price for stable cash flows. Should this trend continue it could be the start of major oil companies starting to put more of their revenues into longer term offshore projects and exploration.
This could be a good thing for ETFs like the SPDR S&P Oil & Gas Exploration & Production (XOP), which have been underperforming along with the oil market. As oil contracts get locked in prices and we see a stabilization in prices from a lack of investing in replacement wells, the yield on this ETF could start to justify higher prices in the future.
On Tuesday the Reserve Bank of Australia (RBA) will meet for an interest rate decision and have a meeting. Many are expecting no change in policy and in light of some recent economic numbers, some investors are expecting the debate within the bank to start to hinge towards the possibility of rate hikes and less away from the timing of the next cut. The shift from a loosening to tightening policy will depend more on the outlooks from China and their needs for commodities than domestic growth in the country.
China will come out with their manufacturing numbers early Tuesday followed by Europe and the UK (the US numbers are today). Watchin these numbers, coupled with Australia's reliance on the commodity sector growth (and inflation) it would be wise to track these numbers, especially in the APAC region.
The RBA mentioning in their meeting about the recent rise in inflation could spur the Aussie dollar to strengthen back down to levels seen after the US elections when the reflation trade was in full swing. The anticipation of higher interest rates would make the currency more attractive and could help stem the growth in debt levels that are keeping many investors on the sidelines in terms of longer term investment in the country.
Global markets started the week on a down note from US political dysfunction and rallied in hopes of tax reform. In global affairs the markets seem to be discounting (or have priced in) the official invoking of article 50. Given the dramatic shifts in US politics, it is easy to understand why there is less emphasis on an event that will take 2 years to sort out. This is why it will be important to understand what could be over the horizon and find opportunities or risks while others worry in the near term.
The Pound remains at a post-brexit low and seems to have a lot of bad news baked into it. It would make sense from a longer term point of view to look for opportunities in certain asset classes (such as Gilts) that will provide some upside potential and favorable exchange rate movement. With elections in France and Germany this year there will be plenty of volatility and headlines to create some buying opportunities in the UK market and being prepared for those opportunities will be important. It should be good to have a base case scenario and list out what is expected bad news vs unexpected. Below is a good start to this list.
The Fed will speak in a few hours and the almost no one is expecting rates to remain the same. As discussed earlier the markets seem to be taking this rate hike in stride because the Fed seems to have waited to the very last minute to leave make sure there was nothing that could support a delay in rate hiking. What will be important to look for is the language at the conference. How the conference manages the expectations of the Fed going forward will play a large role in the markets going forward.
Should the Fed get more aggressive in their language, and appear to want to head off inflation, the markets could take a pause and revalue equities on that assumption. If the Fed instead keeps the appearance of only raising rates in the absence of any data giving a reason to hold, then markets will feel the economy can expand without much interference from higher borrowing costs.
It will be important watch the Fed futures for June, which is slightly to the advantage of another rate hike, and the end of year overall projections. Should these tick towards more rate increases because of an aggressive fed it will no doubt introduce volatility and readjustment in the equity and currency market.
With nonfarm payrolls coming in at 235K, they beat most expectations. This leaves very little in the way of a rate increase this month by the Fed. What will be important to look out for is how aggressive the Fed seems to look in terms of future rate hikes. Like the ECB coming out stronger than expected in their remarks, a similar tone could spark rallies in yields and currencies here in the US. A quick drop in the dollar is now being reverse (with the exception to the Canadian dollar due to their strong job numbers) as people digest the news. This also led to a rally in the US market futures.
This mixed signal of wall streets whisper number seeming to be higher means very little in the face of the Fed who was looking for bad numbers as the only hindrance to a March rate hike. So should these trends in the dollar and the markets keep in this direction all day, it could just be a traders opportunity to bet on the reversal, but nothing more.
An interesting correlation was seen in the markets yesterday. With the Federal Reserve coming out with hawkish sentiment for a rate increase this month (now over 80% likely), the markets rallied. In the past this was a good reason for the markets to sell off, re-valuing equities to higher discount rates. Now the opposite has occurred and it is tough to understand what to think of rate increases going forward. The best way to make sense of this seemingly reversed trend is to look at where the markets feel the Fed is in terms of combating inflation.
In the past the Fed has been reluctant to increase rates at the cost of the fragile recovery. This caused one rate increase per year over the last two because of concerns with brexit, elections and a lack of inflation. This put the market in the mindset that the Fed would like to see a very strong sign on recovery before taking action on inflation alone. During the end of last year inflation creeped up and now the Fed is changing it tune to raising rates despite Trumps tax and regulation plans. In the near term this expresses that the Fed seems to be a bit behind the curve, due to their caution, and have pushed up their rate hike to this month. This gives the market a signal that the Fed feels things are better than their previous expectations. If the Fed looks to try and correct this mistake with taking action with less external factors in consideration, the market could perceive future rate hikes differently in the future.
Should the Fed start to look at inflation rates alone and not worry as much about political and market turbulence in their decisions, the pace of rate increases could become less accommodating to markets. This drive to get ahead of inflation could lead to rate increases while the markets stagnate and bond becoming more attractive with an introduction of volatility.
That isn't to say that a rate hike is going to reverse the post-election rally, but it will certainly start to move independently of market expectations and could travel a path not aligned with high stock valuations. At a minimum it will make alternatives to stocks a more attractive prospect in the future.