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Money Market Report: Higher interest rates sooner for the United States?

August 3, 2014

As the holidays come to an end, NBK's Treasury Group notes a very busy data week in the US in conjunction with the FOMC meeting. All these events have given the market some hope from the emergence of volatility, as signs of wage inflation emerge and GDP rebounds, which has the USD bulls excited.

After Wednesday's GDP numbers, USD bulls did not need much encouragement to take the USD higher. Indeed, the US Dollar continued its steady appreciation this week mainly against the low yielders. 

In Europe, while the greater sanctions imposed on Russia are making investors nervous, the Euro continues to be sold in favor of the US Dollar. However, as the week ended, the Euro held well even with the strong US data.

Meanwhile, in Latin America, Argentina seems to have defaulted on its bonds payments as investors await the official confirmation that the credit Default Swaps has been triggered.

In summary, on the foreign exchange side, markets closed the week with a slightly lower EUR and GBP against the US Dollar. Indeed, Euro fell to a new low for 2014 but its range is still just 3.9% and investors have little choice to go with the break or at least hold their short positions.

The Sterling Pound on the other hand continued its correction. After reaching a low of 1.6814 on Friday, the Pound ended the week near the low of 1.6821. Euro on the other side behaved similarly closing the week near the low as investors still hesitating to buy the currency. The currency closed the week at 1.3430.

In the commodities markets, Gold broke below the $1,300 psychological level, as the employment data out of the US remain on track.

Exceptionally Strong US GDP in Q2

After a difficult start of the year, the U.S. economy was much stronger than expected in the April-June quarter, growing at a fast annual rate on the strength of higher consumer and business spending. Indeed, Gross domestic product grew by 4% on an annual basis, better than the average of 3% predicted by economists. In the first three months of the year, the economy shrank by 2.1%. Annual revisions also released on Wednesday show the economy grew by 4% in the second half of 2013, its fastest pace of growth in a decade.

US: Strong Employment Report, however, enough to make the Fed stay on hold

In a report released on Friday, the U.S. Department of Labor said non-farm payrolls rose to a seasonally adjusted 209K, from 298K in the preceding month whose figure was revised up from 288K. Indeed, the 209,000 number was short of the 233,000 expected by economists. The jobless rate ticked up to 6.2%, higher than the 6.0% economists had expected. It is worth noting that this report is not unambiguously negative for the USD. It implies that there is more capacity so that the US can grow further, and if the Fed delays its rate hike, it could be able to do more to help improve the economy.

The first rate hike is now fully priced for the June 2015 meeting and we are just 10bps away from pricing 2% by the end of 2016, which is arguably the Yellen dot. Thus, what the market is currently doing, is just catching up to the Yellen dots, and we don't have enough just yet, in terms of data, to "out-hawk" the Fed. Indeed, there may not be much of an inflation cost to pushing policy but if the market perceives you have fallen behind the curve, there is too much leverage in system.

Richard Fisher: Higher Interest rates sooner?

Federal Reserve Bank of Dallas President Richard Fisher said this week he believed the timing has moved up for the first main interest rate increase from close to zero because of a strengthening economy and higher inflation.      "It would seem to me and I have been arguing this that the date of so-called liftoff has been moved forward," Fisher said in a TV interview. "I believe personally we have moved that forward significantly."

Fisher voted for the Fed's decision this week to trim monthly bond buying by $10 billion to $25 billion and to keep interest rates low for a "considerable time" after ending purchases.

Europe: PMIs missing expectations

Early on Friday, the market received manufacturing PMIs for the Euro Zone. First out of the blocks was the Eurozone with their aggregate number falling to 51.8 from 51.9. While manufacturing growth picked up in Germany, the French PMI fell to a seven-month low and there was a renewed downturn in Greece alongside slowing growth in Spain and Italy. This will make sober reading for the ECB as inflationary pressure evaporates and factory activity shrinks despite factories barely raising prices, but the ECB will give some time for their already prescribed measures to take effect before taking further action.

Eurozone CPI drops to near five-year low

The data release this week was the disappointing release of Eurozone CPI for July, which fell to its lowest level since the height of the financial crisis nearly five years ago. Consumer prices in the 18 countries sharing the Euro rose by 0.4% on the year in July, the weakest annual rise since October 2009 when prices fell by 0.1%, the EU's statistics office Eurostat said.

The weak reading was mainly fuelled by downside surprises in Italy and Spain. The core inflation remained steady at 0.8% for the second month in a row. The markets did not really react to the weaker print, as the European Central Bank has signaled they want to wait for TLTROs in the second half of the year before considering other policy options. The bank holds a policy meeting on the coming Thursday and the analysts expect it to stay put, reflecting signals from the Governing Council that more time is needed to assess the impact of its latest measure on the real economy.

Correction after strong UK data

In the UK, PMIs showed that British manufacturing grew at the slowest rate in a year in July, falling to 55.4 from 57.2 in June, having come in between 56 and 58 over the past 11-months. Market said growth was strong by historical standards and the slowdown was in line with the Bank of England's view that Britain's strong recovery will slow a touch in coming months. Nevertheless GBPUSD dropped 50pips to and continued its downtrend, currently trade down 0.34% for the day at 1.6829. Over the past 14-days trading days the currency pair has dropped 1.84%

Argentina defaults on bonds interest payments

This week, the Argentinean bond negotiation came to a dead end. After the US market close on Thursday, S&P downgraded Argentina to "Selective Default" after the rating agency said that holders of discount bonds did not receive their interest payment. Argentina's negotiators and a small group of hedge funds in New York failed to reach a deal before a deadline to make $539 million in interest payments. As the situation that stems from the 2001 $100bn default continues, it remains unclear exactly what the next steps are for the Argentine government and its creditors.

Default has now become a fact, and the missing of a payment will provide a basis to trigger a Credit Default Swap. The ISDA's determination committee will make a definitive decision on CDS in the next couple of days.

China PMI highest since 2011

China's official PMI was reported at 51.7 versus expectation of 51.4, the highest since May 2011. Analysts have noted there was strong improvement across the most of the sub-indices in the breakdown. They suggest domestic demand is gradually picking up given the recent string of stimuli introduced. With Small and medium Enterprises still cautious in their outlook and employment index having fallen, they do expect the authorities to introduce more stimuli. Without doubt, today's good China official PMI data should help reduce some of the worries market participants have on Asian FX at least in the short term.

Weaker outlook for Australia in 2015 and 2016

While analysts do not expect a change in rates at the Reserve Bank of Australia'sAugust Board meeting, they think there is a possibility that the Bank's description of the policy stance in the post-meeting statement shifts to less specific guidance than has been the case for the past six meetings.

This is reinforced by the fact that the RBA's latest Statement on Monetary Policy is also due for release this coming week. Analysts expect the board to outline an incrementally weaker outlook for activity next year and in 2016. They do not anticipate much change in the outlook for underlying inflation, although the near-term forecast for headline CPI will be reduced, reflecting the recent repeal of the carbon tax.

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Source: CPI Financial

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