Top Things to Know Today - page 29
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Picking Up Pennies In Front of a Steamroller and FOMC, BoE, BoJ Ahead
Talking Points:
Complacency isn't the proper word for the general course the investment community finds itself on. Reckless is. The reach for yield is not a new phenomenon for the the market. We have seen the cost of entry into assets outstrip economic fundamentals, rates of return and forecasts for the future for years. Yet, that shouldn't desensitize us to the risk that such exposure to 'risk' represents. It isn't the record high on the S&P 500 that should concern, but the leverage behind the market. VIX at a two-and-a-half year low looks far more sinister when we appreciate the appetite for leveraged ETFs or the record short position in the volatility index's futures contracts. Even the rise in the more risky assets (Emerging Market and High-Yield ETFs) isn't dangerous until we consider its progress comes against exponentially greater threats like the breakdown of trade relations.
The balance of the fundamental opportunity in the financial system is severely skewed. Building on a risk-oriented position is an extraordinary threat and will yield very little return for the exposure taken. Alternatively, the seemingly impossible turn in sentiment can devastate some an ill-prepared market. This should not keep us from actively trading in the markets, but it demands we be more circumspect of what we are getting into. Is the strategy, size, duration, exit plan and other important aspects of a trade intend to execute fully accounted for? What happens to this position if sentiment were to suddenly reverse course? These are questions that should be considered with all new trades placed going forward.
With a difficult trading environment to work with, the week ahead should look more risky than opportunistic. We have a laundry list of critical, scheduled event risk but a warped fixation on what can truly drive the market. The FOMC rate decision and January nonfarm payrolls (NFPs) are great catalysts for rate speculation - the central bank is very unlikely to lift at this meeting, so speculation over subsequent gatherings is its primary use. However, the yield advantage the Dollar has rallied on over the past few years has taken a backseat to concerns over the United States' trade policies with the new President. Similarly, the Bank of England rate decision could pull the Pound back up from a dovish setting, but Brexit is the focus for the UK currency. What do the markets imply versus what will they actually offer traders in the weeks ahead? That is the focus of this weekend's Trading Video.
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1. US Federal Reserve Interest Rate Decision
The US Federal Reserve Open Market Committee (FOMC) rate decision will be announced on Wednesday February 1st at 14:00 EST.
There will be no updated economic forecasts and no revisions to the ‘dot plot’ Fed Funds rates forecasts by individual FOMC members at this meeting. Chair Yellen will also not hold a press conference after the decision.
There is very little chance that interest rates will be increased following the move to raise rates at the December FOMC meeting.
All the focus will be on the statement and the underlying tone is likely to be one of a holding operation as the FOMC waits for fresh evidence on economic trends and legislative changes.
There will be an optimistic take on the economic outlook and confidence in the labour market. At this stage, the Fed is unlikely to give guidance on future policy, especially given the high degree of uncertainty surrounding fiscal policy, but there will be a tightening bias.
Markets will be looking for any warnings that an agenda of tax cuts could trigger a faster pace of rate increases. Any commentary on fiscal policy could be the most important element of the statement, although the FOMC is likely to be extremely cautious over veering towards political territory and take a holding brief for now.
2. Bank of England Monetary Policy Decision
The Bank of England will announce its latest monetary policy decision on Thursday February 2nd at 07:00 EST.
The Bank of England will also present its latest inflation report, policy summary and minutes, while Governor Carney will hold a press conference.
This will be a very important Bank of England meeting, especially with publication of the latest inflation report.
The main focus will be the latest inflation and growth forecasts with the potential for growth forecasts to be revised slightly higher. Any increase to the inflation forecasts would also increase speculation that the Monetary Policy Committee (MPC) will need to move to a tighter policy.
Any move away from a neutral policy to a tightening bias would be a very important market signal and have a substantial impact on UK markets.
Markets will also be looking for any guidance on the bond-buying programme and whether it is likely to be extended once the latest tranche of £60bn of purchases is completed.
The minutes will also be a significant focus as there is the potential for a significant increase in divisions and divergence within the committee. The more hawkish members of the committee are likely to be increasingly uneasy over the current policy stance and potentially more open in calling for policy tightening.
The PMI manufacturing data will be released on Wednesday with the services-sector data due on Friday.
3. US Employment Report
The US employment report will be released on Friday February 3rd at 08:30 EST.
The employment report will, as always, trigger a substantial short-term reaction and market noise.
There is again the risk of faulty seasonal adjustment for the January data with statisticians assuming that a large number of seasonal jobs come to an end in January. If the actual number of hires was substantially different from normal, there can be an erratic figure for January non-farm payrolls.
There could be a small impact from post-election optimism, although it is unlikely to be a major factor. Unless the change in non-farm payrolls is substantially away from estimates, it will probably be the least important aspect of the report.
The unemployment and participation rate data will be important elements, especially as the Fed considers that the economy is very close to or at full employment. A significant decline in the unemployment rate would increase concerns over the risk of overheating.
Following the sharp increase of 0.4% for December, the average earnings data will also be a very important focus. Another strong increase in earnings would increase expectations of higher inflation, which would also trigger alarm within the Fed. A relatively low figure would dampen short-term inflation expectations and give the Fed some increased room for manoeuvre.
The ISM manufacturing data is due on Wednesday with the consumer confidence data on Tuesday after the surge seen for last month.
4. Bank of Japan Policy Decision
The latest Bank of Japan policy decision will be announced on Tuesday January 30th local time (around 23:00 EST Monday).
There is no fixed time for the decision and statement.
The Bank of Japan is likely to be more optimistic surrounding the economic outlook and inflation forecasts could be revised up slightly further.
Energy prices have, however, dipped from their highest levels and USD/JPY has also pulled away from December highs above 118.50 against the yen. These two factors will tend to lessen upward pressure on inflation and maintain Bank of Japan caution.
The increase in global bond yields will be a key focus and will provide an important test of Bank of Japan policy. Under its policy of controlling the yield curve, the central bank aims to hold long-term interest rates around zero through bond purchases.
Higher global yields will, however, make this policy more difficult to sustain and potentially require increased bond purchases. There will, therefore, be speculation that the central bank will let long-term rates move higher, which would also support the yen.
5. Eurozone Inflation Data
The Eurozone CPI inflation data will be released on Tuesday January 31st at 05:00 EST.
The Eurozone inflation data will be watched very closely this month after the sharp increase in the annual rate seen for December.
The German data will also be watched very closely the previous day, especially after a big increase in the December year-on-year rate to 1.7%.
Base effects will continue to have an important impact given that prices fell sharply in January 2016 and there is a strong probability that there will be a significant increase in the annual rate with consensus forecasts for an increase to 1.5%.
A sharper than expected reading for the annual inflation rate would increase speculation that the ECB would shift towards a tapering of bond purchases within the next few months.
The core data will be watched closely with the ECB attempting to look through a sharp increase in the headline rate, although this would not prevent a shift in market expectations.
Any further strong increase in the German rate would also increase Bundesbank opposition to the current ECB policies.
BNP say recent USD weakness unwarranted, but warn risk is Trump's unpredictability
We believe the recent USD weakness is unwarranted, especially compared to the gap that has opened up with relative interest rates. USD long positioning has moderated significantly and now stands at just +1 on our +/- 50 BNP Paribas Positioning scale, the lowest level since the US election.
Furthermore, stronger US data and upside inflation surprises indicate that markets are underpricing Fed rate hikes for 2017 and 2018.
We therefore think this is an opportune time to reload USD long exposure. We keep USD longs (via options) versus the JPY, EUR & CAD.
The risk to the bullish USD view likely surrounds the unpredictability of the new US President. It may take time for Trump and Congressional Republicans to agree on tax plans. Furthermore, consumers and businesses may be more optimistic, but are choosing to wait to see how policy plays out before committing actual money.
Germany December retail sales mm -0.9% vs +0.6% exp
Germany December retail sales report 31 Jan