At close Dec 18, 2014
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- As expected, the U.S. Federal Reserve (Fed) concluded their quantitative easing (QE) program
with a final $15 billion taper of asset purchases. The tone of the statement was more hawkish than
expected, evident in the composition of dissents changing once again, this time to a dovish dissent
from Minneapolis Fed President Narayana Kocherlakota. In sum, the statement suggested the
committee view June 2015 as the most likely date for the first hike, with investors continuing to
expect a slightly later date.
- Regarding Europe, the data picture remained weak. The German Information und Forschung (IFO)
business survey also suffered continued weakness but this seems to be an outlier when compared
to other confidence measures across the region and purchasing managers’ index (PMI)2 in Hungary
and Poland which seem to have stabilized and begun to move higher again. The German Center
for European Economic Research, or ZEW, survey of economic sentiment continued its decline to
-3.6 signaling expectations of further deterioration in the economic environment by respondents.
The contraction can partly be attributed to the economic sanctions placed on Russia and seasonal
factors although growth seems to have stalled more broadly. Retail sales were stronger than
expected up 1.9% yoy. Preliminary October PMIs generally surprised on the upside with the
composite and manufacturing indices increasing to 52.2 and 50.7, respectively.
- The European Central Bank (ECB) announced operational details of their Asset-backed Securities
(ABS) and Covered Bond purchase program, which commenced this month lasting at least 2
years. In Washington, Draghi reaffirmed his commitment to the use of unconventional measures,
specifically the combination of targeted long-term refinancing operations (TLTROs) and asset
purchase programs, to defend against deflation, however, should these measures not be sufficient
he stated that the council was unanimous in its commitment to use additional unconventional
instruments. He also emphasized that monetary policy alone is not enough to raise productivity
and structural reforms need to be implemented as well as expansionary fiscal policy from
economies with the space to do so. Naturally this was met with resistance from German policy
makers, with Schäuble urging further budgetary discipline and Bundesbank head Weidmann
pushing back against Draghi’s €1 trillion figure for expansion of the ECB balance sheet. The politics
of the ECB remains fraught but Draghi seems to have a majority for the reflationary strategy he is
communicating to markets. As yet there is still little sign that the ECB’s policies have done anything
to halt the slide in expected and realized inflation and the pressure for further easing is likely to
mount as they publish the updated inflation forecast in December.
- The ECB also published results from its Asset Quality Review (AQR) which were generally regarded
as positive by investors. The capital adequacy of 130 Eurozone3 banks was tested, with 80% passing
with a tier 1 capital ratio of greater than the 5.5% minimum threshold in the adverse stress-test
scenario. Those failing were predominantly located in the periphery, with nine Italian banks failing
to meet requirements. One get-out clause is that the data used was from the end of 2013 and since
then much capital-raising has gone on throughout the Eurozone banking sector, however, while
banks may be in adequate shape to increase lending, demand for credit remains exceptionally weak.
- UK data was mixed with September’s Manufacturing and Services PMIs both disappointing at 51.6
and 58.7 respectively. The construction PMI continued to be strong, rising to 64.2, despite the
housing market showing signs of cooling. Industrial and manufacturing production numbers were
below estimates at 2.5% and 3.9% yoy respectively but are still indicative of a sustained recovery.
UK consumer price index (CPI)4 fell further than expected to 1.5% yoy, driven by decreased transport costs.
- Market expectations for the first UK rate hike continue to be pushed back in light of a dovish Fed.
The Monetary Policy Committee (MPC) minutes were dovish, with the committee acknowledging
a slight downturn in UK economic data releases since their last meeting. They voted 7-2 in favor
of keeping the base rate on hold at 0.5% and the tone of the minutes suggest the majority of the
committee are in no rush to hike.
- Japan macroeconomic indicators continued to disappoint with industrial production remaining low
at 0.6% yoy in September. Household spending fell -5.6% yoy in September. The BoJ shocked the
market by expanding the scope of its asset purchase program, increasing the size of QE from between
¥60 and ¥70 trillion annually to ¥80 trillion as it looks to lower already very depressed yields across
the curve. Investors worried the BoJ was going soft on its 2% inflation target, but this latest move
is a clear signal of intent from the BoJ that it remains committed to do everything it takes to get
there. The BoJ’s move was reinforced by the Japan government pension fund which announced a new
allocation target including a big increase in domestic equities and foreign asset holdings.
- Given the volatile nature of the markets in recent months it was no surprise to see risk-adverse
sentiment result in a credit sell-off in October, particularly given technical concerns in government
bond markets. More positively, corporate credit quality remained strong following third quarter
results being in line with expectations. U.S. companies show sufficient outperformance with respect
to profits and revenue, and European firms continued to demonstrate conservative management
and stable results.
- Current default rates are low around 2% with forecasts for the same well into 2015. Long-term
historical averages are in the range of 4.5% to 5%. This bodes well for investments in lower rated
credit. By extension upgrade-downgrade ratios are historically stable, and this bodes well for higher
rated credit holdings.
- The U.S. dollar continued to strengthen against other major currencies.
- Early on, stronger-than-expected U.S. employment data fuelled dollar strength, enabling it to record
a twelfth-consecutive week of appreciation against other major currencies. In contrast, the ECBs
plan for monetary easing caused the Euro to lose ground. However, sterling was even weaker, in
spite of the continued belief that the Bank of England (BoE) would be the first major central bank to
raise interest rates.
- In the middle of the month, the U.S. dollar’s seemingly relentless rise was temporarily arrested by
a feeling that interest rates would be kept lower for longer. This was prompted by Fed indications
of nervousness over rising inflation. However, the dollar’s upward trajectory was resumed as equity
and bond market turbulence was calmed. Towards month end, the Fed removed its remaining
$15 billion of monthly asset purchases, accompanied by an unexpectedly hawkish statement.
Over October as a whole, the U.S. dollar was broadly unchanged against the euro, and marginally
stronger against sterling. Meanwhile, the Japanese yen fell to a six-year low against the dollar after
the BoJ surprise decision to ease monetary policy. The yen also weakened against the euro and
- Elsewhere, currencies exposed to the sharp fall in commodities market came under further pressure.
The currencies of oil-exporting nations such as Norway and Russia suffered, as did the Australian
and New Zealand dollars.
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