The Federal Reserve decision will be the key scheduled event of the week for the US and should result in a formal announcement of the balance sheet reduction strategy. We have known the structure for a couple of months, which is a very gradual tapering of the reinvestment of maturing assets. The bond market has taken this in its stride so far and we do not expect any major volatility due to this announcement. However, the Fed releases new economic forecasts and there will be significant interest in its expectations for the path of the Fed fund’s target rate. Currently the Fed is anticipating four 25bp rate hikes by the end of 2018, whereas the market is only pricing in one such move. We would not be surprised to see the median forecast to show that the Fed now feels three hikes is the most likely scenario, reflecting the more subdued inflationary environment than anticipated and some near-term uncertainty on growth, as a result of the recent hurricanes. For the UK, we will be focusing on BoE speakers. It appears that the BoE is trying to prepare the market for a potential rate hike in November; so, any direct hints from Mark Carney is clearly likely to heighten such expectations and offer further support to sterling. It will be another calm week in Germany, with all political parties preparing for Election Day. No poll results will be released in the last few days in the run up to the election. It currently looks as if the race for No.3 will be the most important aspect of the election on 24 September.

Higher core CPI in Turkey should prolong the CBT’s hawkishness, helping the curve to flatten. Wereceive5yr USD/TRY swap and seethe window to receive the front end postponed to year-end. Our analysis also shows that positioning in TURKGBs is not concerning.
With lower headline inflation but much higher core inflation, our economist expects the CBT to stay on the hawkish side and keep the blended funding rate close to the late liquidity window until year-end. This should prolong the CBT’s hawkishness, helping the curve to flatten. We receive 5yr USD/TRY swap and see the window to receive the front end postponed to year-end. TURKGBs have received US$5.8 billion of inflows YTD. We estimate that US$3.8 billion comes from GBI-EM investors covering their UW positions. Non-ETF and ETF investors could have bought US$1 billion and US$370 million each on the back of strong inflows. This leaves US$745 million of inflows from other investors, which is around 0.6% of the overall TURKGBs market. Using the same methodology, we estimate that non GBI investors have bought around 6% of the SAGBs market this year. Such a comparison suggests that positioning in TURKGBs is not concerning.

Despite the CNB hiking rates yesterday, we do not see much value in being short EUR/CZK and think the risk/reward is unattractive at current levels. However, we do see potential for some gradual CZK gains, given that the CNB appeared more comfortable with currency strength than previously.

In our view, ZAR should underperform and so we continue to recommend short positions. Our expectation for a further 50bp of rate cuts over the coming quarters along with a weak economic position and political uncertainty should continue to weigh on the rand. Moreover, with volatility in core bond markets and uncertainty about G3central bank monetary policy as they become more hawkish, ZAR will likely become increasingly vulnerable. Our pivot to a CNH/ZAR position reduces funding costs at the same time as offering attractive risk/reward. Fundamentally, we think CNH is strong, supported by domestic investment and still strong global trade. What’s more, China’s economic growth rate has been accelerating over recent quarters, with a tight monetary policy environment, and a substantial reduction in capital outflows. We target 2.10 in CNH/ZAR with a stop at 1.93.

A Reuters report indicated that the PBOC may consider widening the USD/CNY trading band to 3% around the daily fixing from 2% currently. While such a reform would be in line with China’s long-term market liberalisation goals, in the near term, CNY spot continues to track the RMB fixing closely amid tighter capital controls this year. China has widened the trading band gradually from 0.5% in 2007 to 1% in 2012 and then to 2% in March 2014. Interestingly,2007 and 2012 were both years of the Party Congress, where the band widening occurred before the Congress meeting. While such a reform would reinforce policy-makers’ focus on financial market liberalisation and increasing confidence in RMB, the market reaction, we think, would depend on the underlying economic fundamentals and USD. The previous two band widenings did see CNY spot weakening to the top of the trading band. However, we argue that China’s fundamentals and expectations on RMB have improved since 2012and 2014, when growth was on a weakening trend and RMB fixings were on a depreciation bias into the two band widenings.

EM-dedicated fund flows over the past week (up to August 2) totalled US$1.92bn of inflows,up from US$1.60bn in the previous week. This is in line with decent one-week returns for both hard currency (0.6%) and local currency (0.4%). Overall EM funds saw net inflows of US$1.48bn to non-ETFs, while ETFs managed inflows of US$454m. Inflows to hard currency funds increased to US$1.37bn (0.73% of AUM), of which ETFs saw inflows of only US$200m,as opposed to non-ETFs, which received inflows of US$1.17bn in the last week. Local currency funds saw inflows of US$612m (0.36% of AUM) in the last week, an increase of 50% over the previous week. Inflows to ETFs decreased marginally to US$254m, while non-ETFs saw inflows of more than four times (US$367m) the previous week. Split by geographical focus, global mandates saw inflows of US$407m while country or regional mandates saw net inflows of US$214m after two consecutive weeks of outflows. Lastly, blend currency funds saw outflows of US$55m (-0.10% of AUM) in the last week. Overall net inflow momentum to EM debt-dedicated funds has now lasted for 27 weeks and amounts to total inflows of US$44.2bn (or US$47.4bn YTD), making it the strongest sustained period of inflows out of the five inflow surges since the taper tantrum.

EM-dedicated fund flows (up to June 7) amounted to US$2.3bn of inflows, an increase of US$500m from the week before. Hard currency funds saw nearly two-thirds of the inflows at US$1.8bn (1% AUM).Local currency funds also saw US$600m of inflows. This brings YTD inflows to US$22bn in hard currency and US$12bn in local currency. Inflows into ETFs stood at 40% of the total, up from 30% YTD. The majority of the ETF inflow is concentrated in one hard currency ETF, showing investors’ appetite for low-cost, passive investment.

China headline PPI slowed more than expected: May headline PPI came in at 5.5%Y,a tenth lower than consensus expectations, reflecting weak commodity prices. However, non-commodity PPI and core CPI in May did hold steady relative to April levels. Yesterday’s FX reserve numbers showed an increase of ~US$3bn in reserves after adjusting for valuation effects, marking the fourth consecutive month of reserve growth. While USD/CNY could move higher in the medium term, we believe that recent CNY appreciation versus USD is a tactical adjustment reflecting USD weakness, and we’ve advocated a tactically bullish stance on RMB.

Slower growth and weakening revenue have weighed on fiscal performance. The weak growth outlook also forced the government to increase nominal spending, with a consequent jump in the annual deficit to its highest since the beginning of 2010. The government measures are to expire by year-end, with likely improvement in budget metrics next year, though currently increasing the Treasury’s borrowing requirement.

According to the Ministry of Finance, the budget deficit will be c.TRY61.1bn at end- 2017 (translating into 2% of GDP, vs 1.9% already as of April, on a 12M rolling basis), implying that stimulus measures like VAT cuts on certain consumer durables, deferral of social security premiums for new hirings, etc, will not be extended. Given that most of these measures are temporary in nature, we are likely to see an improvement in fiscal performance next year, while early elections, ruled out by the government so far, remains a key risk. The debt-to-GDP ratio, on the other hand, is envisaged at c.30%, still comparing favourably with other emerging markets.

TurkStat is due to release 1Q17 GDP data next week. We expect a continuation of the recovery that started in the last quarter of 2016. Recently released indicators hint at some further acceleration in 2Q17 economic activity, with higher PMI in tandem with rising CUR. Improvement in sectoral and consumer confidence after the referendum should also contribute to the recovery.
Following the significant deterioration in recent months, with the lagged spill-overs from TRY depreciation and volatility in food prices, inflation showed a modest improvement in May, from the peak realised in April. However, we think that May inflation will not make any significant impact on CBT behaviour. The central bank is likely to refrain from early easing and keep the current tight liquidity stance for a while, until recovery in the inflation outlook becomes apparent. Apart from the CBT’s liquidity tightness, the continued supportive global environment and a REER close to the lowest level realised since the 2001 financial crisis are likely to support TRY in the near term. Significant external financing needs are likely to remain a source of weakness in the longer term.

Elevated inflation and the CBT’s consequent policy tightening have kept the yield curve inverted in recent months, while an improving domestic climate after the referendum has accelerated debt inflows since mid-April, though foreign ownership of domestic debt remained low. Following a c.150bp rally in the long end from the peaks realised at the beginning of this year, we do not expect further strong performance.

The Monetary Policy Committee (Copom) cut the Selic rate by 100 basis points (bps), from 11.25% p.a. to 10.25% p.a., at its May 31 meeting. The decision was in line with our forecast and that of the vast majority of market participants (43 out of 47 institutions, according to Bloomberg). The communiqué released after the meeting signaled moderate reduction in the pace of the current easing cycle at July’s meeting. The committee’s view is that greater uncertainty regarding the speed of the approval of reforms has deteriorated the balance of risks for inflation. The committee ascribes a higher probability to scenarios in which reforms are postponed and is uncertain of how inflation would evolve in those cases. The document also emphasized that the reduction in pace is still conditional on the dynamics of economic activity, inflation expectations, and the committee’s own understanding of the extent of the current easing cycle. We share the view that the latest political developments have increased uncertainty regarding the approval of reforms.

At least for the next few months, members of Congress will probably not be inclined to approve any significant bills, especially those that require close coordination, such as social security reform. The most likely scenario is that, if approved, the social security reform will be further diluted, therefore with a milder impact on fiscal accounts. As we have already argued in several of our publications, a strong social security reform is required in order to stabilize primary expenditures and, consequently, to comply with the cap on primary expenditures. The more uncertain scenario regarding the approval of reforms in Congress and the recognition by Copom members that the probability of negative scenarios has increased lead us to revise our base-case scenario for the path of the Selic rate in the coming months. We now expect a smaller rate cut in the Selic rate at the Copom’s next two meetings on July 26 and September 6, from 100bps to 75bps. If our forecast materializes, the Selic rate will decline from the current 10.25% p.a. to 8.75% p.a. in September.

The Copom unanimously decided to reduce the Selic rate by one percentage point, to 10.25 percent per year, without bias. The following observations provide an update of the Copom’s baseline scenario: The set of indicators of economic activity released since the last Copom meeting remains consistent with stabilization of the Brazilian economy in the short run and a gradual recovery during the course of the year. If sustained over a long period, high levels of uncertainty regarding the evolution of reforms and adjustments in the economy can have detrimental effects on economic activity; Stronger global economic activity has so far mitigated the effects on the Brazilian economy of possible changes of economic policy in central economies; Inflation developments remain favorable.

Disinflation is widespread and includes IPCA components that are most sensitive to the business cycle and monetary policy. It is necessary to monitor possible impacts of higher uncertainty on the prospective path of inflation; Inflation expectations for 2017 collected by the Focus survey fell to around 4.0%. Expectations for 2018 are around 4.4%, and expectations for 2019 and longer horizons are around 4.25%; and The Copom’s inflation projections for 2017 and 2018 in the scenario with interest rate and exchange rate paths extracted from the Focus survey are around 4.0% and 4.6%, respectively. This scenario assumes a path for the policy interest rate that ends 2017 at 8.5% and remains at that level until the end of 2018. The Committee emphasizes that its conditional inflation forecasts currently involve a higher level of uncertainty. The Committee views the heightened uncertainty regarding the speed of the process of reforms and adjustments in the Brazilian economy as the main risk factor. This arises from both a higher probability of scenarios that may hinder this process, and the difficulty in assessing the effects of these scenarios on the determinants of inflation. Taking into account the baseline scenario, the balance of risks, and the wide array of available information, the Copom unanimously decided to reduce the Selic rate by one percentage point, to 10.25 percent per year, without bias.

The Committee judges that convergence of inflation to the 4.5% target over the relevant horizon for the conduct of monetary policy, which includes 2017 and, to a greater extent, 2018, is compatible with the monetary easing process. The Copom emphasizes that the extension of the monetary easing cycle will depend, among other factors, on estimates of the structural interest rate of the Brazilian economy. The Committee judges that the recent increase in the uncertainty regarding the evolution of reforms and adjustments in the economy hampers a more timely reduction of estimates of the structural interest rate, and makes them more uncertain. The Committee will continue to reassess these estimates over time. In light of the basic scenario and current balance of risks, the Copom judges that a moderate reduction of the pace of monetary easing relative to the pace adopted today is likely to be appropriate at its next meeting. Naturally, the pace of monetary easing will continue to depend on the evolution of economic activity, the balance of risks, possible reassessments of the extension of the cycle, and on inflation forecasts and expectations.

10Y bond spreads have overall widened in the last one week (1W). Central America and LatAm have widened the most, while Asia is the only region to tighten in the last 1W. All the credit rating buckets have widened over the last 1W, with BB rated credits underperforming the most.

10s30s spread curves steepened by 1bp in the last 1W to currently stand at 64bp. On an absolute basis, COL is the steepest curve, while PHI is the flattest. On a 6m z-score basis SOAF and ARG are the steepest curves, while BRA is the flattest.
The CDS-bond basis decreased by 2bp in the last 1W to currently trade at positive 11bp. This leaves the basis close to the 6m average of 10bp. On a 6m z-score basis BRA has the most positive basis, while SOAF, PHI and INDO have the most negative.

After the U.S. Vice President Mike pence visited the demilitarized zones between the South and North Korea and warned that the United States’ strategic patience with North Korea is over and sent a message to North Korea to not to test the resolve of President Trump, Russia has issued a warning to the United States against unilateral action in the region. Vice President Pence said, “In the past two weeks, the world witnessed the strength and resolve of our new president in actions taken in Syria and Afghanistan……North Korea would do well not to test his resolve or the strength of the armed forces of the United States.”

Speaking at a news conference, the Russian foreign minister Sergei Lavrov said that this is a very risky path. He added, “We do not accept the reckless nuclear missile actions of Pyongyang that breach UN resolutions, but that does not mean that you can break international law………I hope that there will not be any unilateral actions like the one we saw recently in Syria.” Russia has also warned the United States against further unilateral actions on Syria.

China is reportedly working with the United States to resolve the issue with North Korea. However, the North Korean regime has so far remained defiant. It test fired a ballistic missile to commemorate the 105th birthday of the country’s founder Kim Il-Sung but the test failed as the missile detonated immediately after launch.

The New Zealand bonds closed a tad higher at the time of closing, following a drop in the country’s business confidence. Also, investors are curiously eyeing the GlobalDairyTrade (GDT) price auction, scheduled to be held on April 5 for detailed direction in the debt market.

The yield on the benchmark 10-year bond, which moves inversely to its price, fell 1 basis point to 3.21 percent at the time of closing, the yield on 7-year note also slipped nearly 1 basis point to 2.80 percent and the yield on short-term 2-year note also traded 1 basis point lower at 2.16 percent.

New Zealand’s business confidence eased in March. However, other survey indicators remain fighting fit. Firms are optimistic about their own businesses, and still, want to hire and invest. The survey continues to point to solid growth.

The construction sector remains optimistic but showed a large backward step across some survey metrics. Inflation expectations continue to nudge up. Investment intentions eased from +22 to +21; that’s still a good tempo. Employment intentions are still pacing themselves. A net +23 are looking at hiring more staff, down 1 point. Profit expectations eased from +24 to +23, led lower by construction.

Data from Statistics South Africa showed on Wednesday that the nation’s headline consumer inflation slowed to 6.3 percent year-on-year in February from 6.6 percent in the previous month, matching consensus estimate in a Reuters poll. This was the weakest inflation reading since September 2016, when prices had risen 6.1 percent.

On a month-on-month basis, inflation rose to 1.1 percent from 0.6 percent previously. The month-on-month rise missed expectations at 1.2 percent. Core inflation which excludes the prices of food, non-alcoholic beverages, petrol and energy, inched lower to 5.2 percent year-on-year in February from 5.5 percent and rose to 1.1 percent on a month-on-month basis from 0.3 percent.

Separate data from South Africa’s Reserve Bank on Wednesday showed South Africa’s current account deficit narrowed to 1.7 percent of GDP in the fourth quarter of 2016. The reading was the lowest shortfall in nearly six years, and compared to a revised deficit of 3.8 percent in the third quarter.

Analysts had expected a 3.5 percent deficit for the quarter. For the year as a whole, the current account deficit narrowed to 3.3 percent of GDP from 4.4 percent in 2015.

The consensus expects the ECB to allocate EUR110bn via its target LTRO after allocating EUR62.2bln at its last operation. Given that this is the last TLTRO allocation, demand could be heavy and should the allocation exceed the EUR110 expectation,excess EUR liquidity will be parked at the front end of the EUR curve pushing rates lower, which at the margin is a EUR negative. However, for developing a more pronounced bearish impact on the EUR the liquidity boostneeds to impact the 2-year EUR swap. A decline of the German Schatz yield is not sufficient for driving the EUR lower. ECB’s Nouy (8am) and Lautenschlaeger (3pm) will speak today.

EM and risk outlook stays relatively supported but we see risk aversion alert signs across the board. While investors focus on US politics and especially on today’s vote on the repeal act of Obamacare, other developments should, in our view, not remain unnoticed: a research paper published by two Fed economists and released by the Brookings Institute suggesting US interest rates staying low with the Fed tolerating inflation overshooting targets, the ECB’s targeted LTRO allocations, and the continued fall of iron ore futures. Despite equity markets retracing some of the post-election rally, US monetary conditions have become more accommodative with the falling USD contributing most to this easing. Foreign conditions have turned from providing hefty headwinds as experienced from 2012-16 into tailwinds, helping US reflation gain momentum over time. Accordingly, we prepare for putting on FX trades that benefit from a steeper US yield curve. Short EURSEK and long USDJPY fall into this category. While short EURSEK should work from now, USDJPY’s current downward momentum suggests waiting for 109.50 or for a stabilisation above 112.50 before establishing longs.

US vote: Today markets will wait for the outcome of the vote but FX investors should note that the vote is not scheduled for a specific time. At the moment the vote count may be low so the Republican leaders need the time to gather votes, indicating why no specific time is provided. There is even a risk the vote may be delayed if the leaders feel the vote may not pass.

Watching iron ore. The PBOC-run Financial News newspaper highlighted that the recent rise of RMB money market rates should be put into the context of recent money market operations. China seems to be tightening its monetary conditions to deal with excessive leverage. Importantly, tighter RMB lending conditions have sparked China’s USD denominated loan demand, pushing its USD denominated liabilities up again. Should this loan-related USD inflow into China end up into a higher FX reserves (see chart below) – thus providing an additional signal that offshore USD liquidity conditions are on the rise – EM markets should see further inflows. Meanwhile, China has seen the ratio of mortgage loans to total credit of commercial banks reaching uncomfortably high readings. It has been China’s property and infrastructure investment driving commodity – including iron ore – demand. Authorities are now directing growth away from the property market which suggests that commodity prices may ease. Falling iron ore prices will not bode well for the AUD. Within this context we recommend using the AUD as a funding tool for high yield EM longs and for a long GBP position. GBPAUD has moved away from levels suggested by relative forward curves.

The Australian bonds traded in a tight range Tuesday as investors refrained from any major activity amid a light trading session. Also, the Reserve Bank of Australia’s (RBA) March monetary policy meeting minutes, painted a mixed picture of the economy, adding sluggishness to market sentiments.

The yield on the benchmark 10-year Treasury note, hovered around 2.82 percent, the yield on 15-year note also traded flat at 3.21 percent and the yield on short-term 2-year remained steady at 1.81 percent by 04:20 GMT.

The minutes of the RBA March board meeting continued to paint the picture of an RBA unwilling to move official interest rates anytime soon. The Board highlighted a range of positives, but concerns were also raised. The central bank was notably more upbeat about the global outlook and the flow on effect to higher commodity prices.

Concerns surrounding the outlook for the labor market were apparent, with the RBA noting that “conditions had remained mixed” and that “momentum in the labor market remained difficult to assess”. A further mixed picture on the labor market leaves the RBA between a rock and a hard place.

Lastly, markets will now be focussing on the RBA Deputy Governor Guy Debelle’s speech, scheduled to be held on March 22 for further direction in the debt market.

UK’s manufacturing output rose by 1.2 percent in the last quarter of 2016. Boost to competitiveness from sterling’s depreciation last year was probably a key driver of this upturn. The underlying trend is clearly upward, as is indicated by the 1.9 percent rise in Q4 production when compared to the same quarter a year ago, says Lloyds Bank.

Official data for the month of January showed a small fall in output in January and the February purchasing managers’ survey showed a modest decline in the level of the headline index from the previous month. Analysts at Lloyds Bank opine that the declines are probably just temporary retreats after outsized gains in previous months.

“With orders as measured by both the PMI and CBI surveys strong enough to point to further output gains over the next few months, the sector still seems on course for further expansion,” said Lloyds Bank in a report.

Fall in manufacturing investment, however, raises concerns about the sustenance of upside in the longer term. UK manufacturing investment probably fell by more than 4 percent last year, its weakest performance since 2009. The start of the Brexit negotiations will likely create more uncertainty which could hamper investments going forward. Continued sluggish investment growth may add to concerns about the UK’s modest productivity performance, adds Lloyds Bank.

The Westpac-McDermott Miller New Zealand consumer confidence index edged slightly lower in the March quarter. Survey showed that people grew wary about the short-term economic outlook, but extended the nation’s run of optimism to six years.

The Westpac McDermott Miller consumer confidence index fell 1.2 points to 111.9 in the March quarter, but remained above the long-run average of 111.4. The present conditions index decreased 0.2 points to 111.2 and the expected conditions index fell 1.9 points to 112.4.

“March’s slight fall in confidence mainly reflected some anxiety about the upcoming election. It might also reflect concerns around housing affordability or political developments offshore, both of which continued to hit the headlines in recent weeks,” said Westpac Banking Corp senior economist Satish Ranchhod.

The latest economic data showed GDP figures showed that on a per-capita basis, household spending rose by around 2 percent last year which reflected a healthy level of spending confidence. With a growing confidence of consumers in their own household financial security, and a positive outlook for the New Zealand economy we could expect continuing positive consumer sentiment to translate into sustained growth.

Growth in Japan is holding up nicely and economic activity has gained momentum since 4Q16 with the pickup in the global capex and manufacturing cycle. Inflation has started to push back above the waterline. But as Governor Kuroda emphasized at a press conference last week, inflation expectations remain stuck, something highlighted by this year’s spring wage negotiation projected to produce only modest wage increases. With price pressures nailed to the floor, the Bank of Japan (BoJ) doesn’t seem to be in a hurry to raise rates.

“With our USD rates forecasts pushed upward, we now expect that the BoJ will taper its asset purchases at a somewhat slower pace than previously and that QE will end in H2 2019, instead of mid-2019. JGB rates unchanged,” said DNB markets in a research note to clients.

There is an ongoing debate whether the BoJ will have to raise its 10-year bond yield cap because of the lack of JGB liquidity. There seems to be still a split of views inside the BoJ on whether the Bank should or should not raise the 10-year yield target when the real interest rates decline further. The longer the BoJ keeps the 10-year yield target unchanged, the more rapidly it will have to adjust the target later.

Analysts expect the BoJ to maintain the current 10-year yield target through year-end, but if it sees greater yen weakness, it would adjust the target in 2H17. BoJ will have to strengthen communication strategy with forward guidance on its yield curve control (YCC) policy to manage market expectations. It would probably provide the conditions under which the BoJ would raise the 10-year yield target.

“While we expect the BoJ to introduce forward guidance on its yield curve control (YCC) policy relatively soon, we think it would do so in July at the earliest, when the BoJ reviews its economic outlook and discusses its monetary policy stance in the Outlook Report. If it may take time to build a consensus among the board members on this issue, delaying its introduction until October,” said J.P. Morgan in a report.

USD/JPY trades below 100-day moving average. The pair is tracking DXY lower, amid holiday-thinned markets (Japan closed for Vernal Equinox Day) and lack of fresh fundamental drivers. Technical studies are bearish, RSI and stochs are biased lower and MACD has shown a bearish crossover on signal line. 112 levels in sight, violation there could see test of 111.60 and then 111 levels.

As expected, the US Federal Reserve hiked interest rate by 25 basis points in its March meeting. However, aside from the rate hike, there were no major changes in the FOMC forecast or statement, except for few minor tweaks. With March meeting gone, there are now seven upcoming meetings this year and the Fed has forecasted hikes in two of them. Let’s look at the market pricing of the hikes, (note, all calculations are based on data as of 16th March)

May 3rd meeting: Market is attaching 94 percent probability that rates will be at 0.75-1.00 percent, and 6 percent probability that rates will be at 1.00-1.25 percent.
June 14th Meeting: Market is attaching 46 percent probability that rates will be at 0.75-1.00 percent, 51 percent probability that rates will be at 1.00-1.25 percent, and 3 percent probability that rates will be at 1.25-1.50 percent.
July 26th meeting: Market is attaching 38 percent probability that rates will be at 0.75-1.00 percent, 50 percent probability that rates will be at 1.00-1.25 percent, 11 percent probability that rates will be at 1.25-1.50 percent, and 1 percent probability that rates will be at 1.50-1.75 percent.
September 20th meeting: Market is attaching 21 percent probability that rates will be at 0.75-1.00 percent, 45 percent probability that rates will be at 1.00-1.25 percent, 28 percent probability that rates will be at 1.25-1.50 percent, 5.5 percent probability that rates will be at 1.50-1.75 percent, and 0.5 percent probability that rates will be at 1.75-2.00 percent.
November 1st meeting: Market is attaching 20 percent probability that rates will be at 0.75-1.00 percent, 43 percent probability that rates will be at 1.00-1.25 percent, 29 percent probability that rates will be at 1.25-1.50 percent, 7 percent probability that rates will be at 1.50-1.75 percent, and 1 percent probability that rates will be at 1.75-2.00 percent.
December 13th meeting: Market is attaching 10 percent probability that rates will be at 0.75-1.00 percent, 32 percent probability that rates will be at 1.00-1.25 percent, 36 percent probability that rates will be at 1.25-1.50 percent, 18 percent probability that rates will be at 1.50-1.75 percent, 3.5 percent probability that rates will be at 1.75-2.00 percent, and 0.5 percent probability that rates will be at 2.00-2.25 percent.
The probability is suggesting,

There hasn’t been much of a change after the FOMC. The market is still pricing a hike in June and a hike in December. It is still not clear why the market is predicting two hikes in H1 and just one in H2. This is probably because the market is pricing the Fed would keep additional room for easing.
We suspect that if the price of oil tumbles further, so would be the hike odds.

The New Zealand bonds remained weak at the time of closing Friday, tracking softness in the U.S. counterparts amid a quiet trading session that witnessed data of little economic significance. Also, investors will remain focused on the GlobalDairyTrade (GDT) price auction, scheduled to be held on March 21.

The yield on the benchmark 10-year bond, which moves inversely to its price rose 1 basis point to 3.29 percent at the time of closing, the yield on 7-year note jumped nearly 1-1/2 basis points to 2.86 percent while the yield on short-term 2-year note also dived 1 basis point higher at 2.13 percent.

New Zealand’s economy expanded 0.4 percent q/q over the final three months of 2016. That was below consensus expectations and the softest quarterly growth experienced since Q2 2015. Q3 growth was also revised lower to 0.8 percent q/q (from 1.1 percent previously reported). As such, annual growth eased to 2.7 percent y/y.

New Zealand’s Dairy prices fell 6.3 percent in the latest GDT price auction, following a 3.2 percent decline a fortnight ago. Within this, powder prices performed poorly, with whole milk powder prices falling 12.4 percent to USD2,794/MT, and skim milk powder prices falling 15.5 percent. Meanwhile, AMF continues to be well-supported at high levels, edging down only 0.8 percent.

The Political establishment in Washington went into a frenzy last year after then-candidate Donald Trump said that he wants to restore relations with the Russians. Every time, Mr. Trump refused to criticize either Russia or Russian President Vladimir Putin, the established anti-Russia establishment in Capitol Hill went after him and that includes several media outlets like CNN, which colluded with the Clinton campaign during the election and more. The skepticism with Russia runs so deep in Capitol Hill and within the establishment that President Trump is considered by many as a Russian spy and they are still looking to prove connections between Trump and Putin.

A recent incident in Capitol Hill proves how deep the hatred runs. Senator John McCain of the Republican Party presented a proposal that envisions bringing Montenegro, a small Balkan country within the umbrella of North Atlantic Treaty Organization and that proposal was rejected by another Republican senator Rand Paul, who did not want to make additional military commitments when the US debt is already at $20 trillion. Russia allegedly took part in a failed coup during last year’s Montenegro election. Mr. Rand Paul’s refusal triggered a furor in Senator McCain, a well-known Russia hawk, who accused Mr. Paul of working with or for the Russian President Vladimir Putin.

Russia-US-Montenegro are part of global geopolitics and there is also nothing wrong being a Russia-hawk but when one accuses a colleague of working for Russia, then probably it’s not just hawkish; it’s a phobia, Russia-phobia.

The real question is, can President Trump overcome these phobics and reconcile with Russia?

The Australian bonds jumped Thursday as investors poured into safe-haven assets after reading the higher-than-expected unemployment rate for the month of February. Further, the change in employment dropped steeper than what markets had initially anticipated.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, slumped 11-1/2 basis points to 2.82 percent, the yield on 15-year note also plunged nearly 11-1/2 basis points to 3.21 percent and the yield on short-term 2-year traded 7-1/2 basis points lower at 1.81 percent by 03:20 GMT.

The February labour market report disappointed, with a fall of 6.4k jobs and a rise in the unemployment rate to 5.9 percent. The detail was slightly more positive than the headline with full-time jobs rebounding after the previous month’s sharp fall.

The soft tone to the February report provides further confirmation that the RBA is likely to be on hold for an extended period. Spare capacity in the labour market is taking longer than expected to be worked off, and is weighing on wages growth and pushing out the return of inflation into the target band.

Australia’s February business conditions retraced some of the previous month’s gains, but remain at levels consistent with solid growth. Confidence also eased back slightly. Business confidence also edged down in February, alongside a further deterioration in the Federal Government’s standing in public opinion polling.

The Australian bonds traded modestly higher Wednesday as investors poured into safe-haven assets ahead of the February employment report, scheduled to be released on March 16. Also, the Federal Open Market Committee’s (FOMC) monetary policy meeting, scheduled for later in the day will provide further guidance to financial markets.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, fell 1/2 basis point to 2.93 percent, the yield on 15-year note dived nearly 1 basis point to 3.32 percent and the yield on short-term 2-year also traded 1 basis point lower at 1.89 percent by 03:20 GMT.

Australia’s February business conditions retraced some of the previous month’s gains, but remain at levels consistent with solid growth. Confidence also eased back slightly. Business confidence also edged down in February, alongside a further deterioration in the Federal Government’s standing in public opinion polling.

“We expect the February jobs report, out later this week, to show a solid rise in employment, but over the longer term a sharper downtrend in the unemployment rate is likely necessary for a sustained boost to households’ perceptions of their finances,” ANZ Research commented in its latest research report.

Eurozone industrial production growth increased less than expected in January, data from the European Union statistics office Eurostat showed on Tuesday. Industrial production in the 19-member single currency bloc rose by 0.9 percent month-over-month in January and by 0.6 percent year-on-year.

Industrial production data missed expectations in a Reuters poll for an average monthly rise of 1.3 percent and a 0.9 percent increase year-on-year. Higher investment in machinery was partially offset by a drop in the production of consumer goods.

Data for December which initially showed industrial production fell by 1.6 percent on the month, were revised higher to now show a 1.2 percent drop. On a yearly basis, output went up by 2.5 percent in December, more than the 2.0 rise previously estimated.

Non-durable goods output slipped 2.6 percent in January after 1.4 percent gain in December, marking the first decline in three months. Growth in durable consumer goods production also eased to 1.5 percent from 4.3 percent in the previous month.

Capital goods production dropped 0.8 percent following 0.5 percent growth in December. The intermediate goods output slowed to 0.8 percent from 3.6 percent in the previous month. Energy production growth slowed only slightly to 6.9 percent from 7 percent.

The UK gilts slumped Tuesday ahead of the country’s labor market report, due on March 15 and as investors remain cautious ahead of the Bank of England’s (BoE) monetary policy decision, scheduled to be held on March 16.

The yield on the benchmark 10-year gilts, which moves inversely to its price, rose 1 basis points to 1.25 percent, the super-long 25-year bond yields also rose 1/2 basis point to 1.88 percent and the yield on the short-term 3-year traded flat at 0.24 percent by 09:50 GMT.

The BoE is expected to maintain its neutral policy stance at the monetary policy meeting, scheduled to be held on March 16. Further, the central bank is also expected to hold its Bank Rate at 0.25 percent while leaving the targets for the stock of government bond purchases (APF) and the stock of corporate bond purchases (CBPS) unchanged at GBP435bn and GBP10bn, respectively.

“In our view, the BoE seems to be more worried about slower growth than too-high inflation if this is only temporary. EUR/GBP has reached our 1-3M target of 0.87 and we are currently reviewing our forecast. We still see risks skewed to the upside for EUR/GBP in the coming months ahead of and after the triggering of Article 50,” Danske Bank commented in its recent research report.

The German bunds jumped at the start of the week on Monday as investors remain keen to watch the European Central Bank (ECB) Governor Mario Draghi’s speech, scheduled for later in the day. Also, the 30-year auction, scheduled to be held on March 15 will remain crucial in determining the teh future direction of the bond market.

Besides, markets shall remain hooked to assess the speeches by other ECB members Sabine Lautenschlaeger, Vitor Constancio and Peter Praet later through the day.

The yield on the benchmark 10-year bond, which moves inversely to its price, slumped nearly 4 basis points to 0.45 percent, the long-term 30-year bond yields plunged over 4 basis points to 1.22 percent and the yield on short-term 2-year bond traded 1-1/2 basis points lower at -0.82 percent by 08:30 GMT.

The ECB kept all policy measures unchanged at last week’s meeting, which was in line with market expectations. However, Governor Mario Draghi had a hawkish tone during the Q&A session as he said the Governing Council discussed whether to remove the ‘lower levels’ from the forward guidance on policy rates.

Further, on the very short-end, German yield curve, Draghi said the ECB was monitoring distortions. The market reacted by sending German government bond yields higher by around 5bp beyond the 10Y point.

Lastly, investors will be closely eyeing February consumer price inflation, due to be released on March 16 for detailed direction in the debt market.

The Australian bonds rebounded on the first trading day of the week as investors remain glued to watch the February employment report, scheduled to be released on March 15. Further, the 10-year bond yields have formed a ‘bullish gravestone doji’ pattern after two consecutive sessions of selling activity in the last week.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, plunged 3-1/2 basis points to 2.95 percent, the yield on 15-year note also dived 3-1/2 basis points to 3.34 percent and the yield on short-term 2-year traded 1-1/2 basis points lower at 1.91 percent by 04:40 GMT.

Australia’s unemployment rate unexpectedly fell in January, despite a plunge in full-time jobs, underscoring the mixed picture of the country’s labor market. The unemployment rate held below 6 percent partly due to discouraged job-seekers giving up the hunt, underscoring spare capacity in the labor market.

The New Zealand government bonds jumped Monday at the time of closing, following expectations of a drop in the country’s fourth-quarter gross domestic product (GDP), scheduled to be released on March 15.

The yield on the benchmark 10-year bond, which moves inversely to its price plunged 3-1/2 basis points to 3.39 percent at the time of closing, the yield on 7-year note also slipped nearly 3-1/2 basis points to 2.94 percent while the yield on short-term 5-year note traded 2-1/2 basis points lower at 2.64 percent.

The rate of quarterly GDP growth is expected to soften a touch in Q4, partly related to temporary weather influences. Tight supply (rather than meaningfully softer demand) conditions are dominating. The current account deficit should remain at a historically comfortable level, ANZ research reported.

“We estimate that GDP rose by a modest 0.5 percent in the December quarter, following 1.1 percent growth in September. Construction is again expected to be one of the strongest sectors, with primary production and manufacturing likely to be the most significant drags on growth,” Westpac commented in its recent research publication.

President Donald Trump’s Treasury Secretary Steven Munchin has warned the both houses of congress in an open letter of the looming debt ceiling, which is expected to get hit on March 15th. The image of the letter is attached. In the letter he said that the suspension of the statutory debt limit which was done via a bipartisan budget act of 2015 will expire on March 15th of this year and from March 16th, the outstanding debt of the United States will be at the statutory limit. He warns that after that treasury will have to take up extraordinary measures to temporarily avoid defaults on obligations. He adds that after March 15th, it would halt sales of state and local government series (SLGS) and the suspension would continue until the debt limit is either increased or suspended.

Lastly, he encourages the congress to raise the limit at the earliest. President Trump has been critical of debt-ceiling increases in the past. In 2013, he had tweeted the followings,

“I cannot believe the Republicans are extending the debt ceiling—I am a Republican & I am embarrassed! Republicans are always worried about their general approval. With proposing to ‘ignore the debt ceiling’ they are ignoring their base.”

However, this time around, he is likely to support an increase.

China’s new yuan loans fell sharply in February from near-record levels in the previous month but were still higher than expected. Chinese banks extended 1.17 trillion yuan (about 169.2 billion U.S. dollars) of new yuan loans in February, down from 2.03 trillion yuan in the previous month, central bank data showed Thursday.

The People’s Bank of China (PBOC) has adopted a modest tightening bias in a bid to cool explosive growth in debt, though it is treading cautiously to avoid hurting economic growth. Analysts polled by Reuters had predicted new February yuan loans of 0.920 trillion yuan.

China’s new yuan loans remained relatively strong in February, led by long-term household loans and corporate lending. Household and corporate long-term loans, in combination, accounted for CNY982.2bn or 84% of overall monthly new yuan loans.

The M2, a broad measure of the money supply that covers cash in circulation and all deposits, grew 11.1 percent from a year earlier to about 158.29 trillion yuan. The M1, a narrow measure of the money supply which covers cash in circulation plus demand deposits, rose 21.4 percent year on year to 47.65 trillion yuan.

“We see little chance for monetary policy to return to easing. In addition, the PBoC should continue to re-shape the interest rate curve in the money market, with higher 7-day reverse repo rates and Medium-term Lending Facility (MLF) rates,” said ANZ in a report.

Commodity markets are taking centrestageas oil had its largest one day fall (- 4.5%) in 13 months. Oil net long positions from the CFTC have been overextended since the start of the year, but it was the combination of technicals and ever more inventory builds in the US that gave investors the signal to take profit. Within G10, CAD has been, and should continue to be, more sensitive than NOK because leveraged market positioning is still very long CAD. CADJPY is sitting on its 100DMA, with a move below 84.20 marking a technical break. AUDUSD is about to break below its 100DMA at 0.75,helped by iron ore prices falling 9% from their peak, keeping us bearish on this pair. AUDUSD has bounced off the top end of a trend channel, bringing the bottom end of the channel at 0.7080 into focus. Even with expectations of a neutral Norges Bank next week (or essentially less dovish than last time), we stick with our tactical long USDNOK trade of the week.

Oil inventory data from the EIA showed a rise of 8.2mb to 528.4m, which is the highest in the data series going back to 1982. US producers appear to be ramping up production quickly, helped by stronger margins from high oil prices and relatively low funding costs. According to Reuters, producers in the red-hot Permian Basin in Texas are expected to increase production soon. An observation from our oil desk highlights the extent of the extreme technicals. They say that there hasn’t been a time in the last 30 years when the weekly front end Brent contract has been in such a tight range, trading sideways for three months. The longer that went on for, the more positioning stresses built up, explaining the sharp drop yesterday. The next formal OPEC meeting isn’tuntil May 25.

The DXY is still under performingtherisein positive US data surprises: Yesterday’s bumper ADP jobs estimate of growth of 298k in February beat market consensus of 187k. Our US economist has revised up his NFP expectation from 200k to 250k. Jobless claims hitting a series of record lows all year, combined with one of the warmest Februarys on record, has helped outdoor industries like construction do well. The market now prices a 100% probability of a hike in rates by the Fed next week, and so any USD strength needs to be driven by expectations of a faster pace of rate hikes in 2018.

JPY: Investors sensitive to US yields: Weekly security flow data for last week showed Japanese net selling of 1.13trn of foreign bonds. There will likely be some volatile data in the run-up to fiscal year-end (March 31) but we think there should be more focus put onto country reallocations for Japanese investors, with a potential to shift into higher-yielding assets. Yesterday the Nikkei reported that the Japanese Financial Services Agency will start to audit regional banks who have large exposures in foreign debt. In particular, concerns have been raised about losses made on US Treasuries. The benefits of USD rising versus JPY as US Treasuries sell off are not there if the bank is holding the foreign asset with an FX hedge. This story needs to be watched to see if changing governance may push Japanese banking sector investments locally instead of abroad. Thinking about that flow, it may actually still be bearish for JPY if it puts downward pressure on JGB yields or increases local lending. If the BoJ’s central bank liquidity turns into ‘high-powered liquidity’ as the banks lend more to businesses, this would help local inflation and thus weaken JPY. Selling EURGBP over the ECB: Today’s market focus will be on the ECB press conference and specifically how much more confident Draghi is about the recovery in inflation. Should the market, against our economist’s expectations, perceive today to be a hawkish outcome, then we think that EUR will trade in two stages. Initially EUR should rally as bond yields rise (with our limit being at 1.08). However, the bond yield rise may be disproportionate across the region, causing spreads to widen. The spread widening is not a good sign for the monetary union as it will highlight further the divergence in economic data performance. EUR should fall as markets realise this and EUR becomes inversely correlated with peripheral spreads. On the UK side, Nicola Sturgeon has suggested to the BBC that a second independence referendum in autumn 2018 would make sense but still stresses thatno final decision has been made. This story adds to our bullish GBP view since it may bring Theresa May’s approach to the Brexit negotiations away from the ‘hard Brexit’ and towards the middle to accommodate Scottish views. We think that Brexit risks are largely in the price and still like selling EURGBP, with a stop at 0.88.

As a harbinger of what may be in store in Friday’s US jobs report, surprisingly strong ADP data pushed bond yields higher yesterday. The 10yr UST yield topped 2.56% as markets assess the Fed’s potential hiking pace for the year. The discounted odds for a hike at the March meeting have risen to 90%. By the end of the year the effective fed funds rate is now seen some 65bp above the current average, which can be interpreted as a c. 60% probability for a third hike this year being discounted.
10yr Bund yields were dragged higher alongside to 0.37% with Bund ASWs largely reversing Tuesday’s widening. EGB spreads versus Bunds saw only moderate widening pressure with 10yr OAT/Bund widening just 1bp yesterday, while only slightly underperforming OLOs. With a new Harris poll showing Macron overtaking Le Pen in the first round, OATS may receive some tailwind today.
ECB meeting. Today’s focus will be squarely on the ECB, but we do not expect any changes to policy or communication against the backdrop of increased political risks. Rather we believe that the ECB will want to reinsure markets with more dovish tones. Nonetheless, the money market curve re-steepened yesterday, dragged higher with the overall rates market. The June 2018 ECB dated EONIA forward is up at -0.24bp again, some 11bp above current average EONIA fixing. We doubt whether the ECB will alter its forward guidance already at today’s meeting, although a risk remains that larger revisions of the staff forecasts might outweigh an unchanged guidance. Our economists believe smaller upticks to the headline inflation projection on the basis of adjusted underlying assumptions regarding oil prices and/or the exchange rate might be possible. However the core inflation profile should be more important, and here the ECB is more likely to reiterate that there is little evidence of self-sustainable inflation yet. Accordingly, we do not expect any discussion regarding a tapering to have occurred at this point.
EGB supply. Only Ireland will be active today reopening the IRISHs 5/26 and 2/45 for a combined €1-1.25bn. Italy announced a new 7yr BTP 5/24 (€3-3.5bn) for auction on 13 March. Alongside the Tesoro will also reopen the BTP 10/19 (€2.25-2.75bn) as well as the BTPs 9/33 and 9/46 (combined €2-2.75bn).

Minneapolis Fed President, who is a voting member in this year’s FOMC stand out among the policymakers who have been calling for faster rate hikes in 2017. Some of the well-known doves of FOMC shifted their camps in recent weeks but during an interview with the Reuters, Mr. Kashkari indicated that he would maintain his dovish outlook with regard to interest rates.

Mr. Kashkari believes that the US labor market has more room to run and he remains cautiously optimistic of the recent trend where in the past 18 months, more workers have returned to the workforce. He said that while wages are rising and hope that the trend would continue, he believes it has yet not reached alarming levels. He said that the Fed aims to let the economy run as fast as it can as long as the inflation is low.

With regard to fiscal policies, Mr. Kashkari said that he hasn’t factored them in his forecasts yet due to lack of clarity.

These comments from Mr. Kashkari doesn’t change our FOMC dashboard for March meeting, which as of now looks like below,

Doves – Neel Kashkari.

Hawks – Janet Yellen, Charles Evans, Patrick Harker, Stanley Fischer, William Dudley, Lael Brainard, and Robert Kaplan

Unknown – Jerome Powell

Pls. note that one of the dovish members, Daniel Tarrullo has resigned and the position is yet to be filled.

The Australian bonds continued to slump Wednesday as investors cashed in profits after the Reserve Bank of Australia (RBA) remained on hold at the latest monetary policy meeting held yesterday, hinting at no further policy easing in the near-term.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, jumped nearly 5 basis points to 2.87 percent, the yield on 15-year note also climbed nearly 5 basis points to 3.28 percent while the yield on short-term 1-year traded 1 basis point lower at 1.61 percent by 05:00 GMT.

The RBA has left the official cash rate on hold for a sixth straight meeting on signs the economy is strengthening and business investment has picked up. The decision to maintain rates at current levels comes as the labor market, inflation and wages growth continue to stutter at the same time that growth has recovered, housing prices continue to surge and business and consumer confidence hover around multi-year highs.

Further, the central bank expects the economy to grow around 3 percent annually over the next several years on steady consumption growth and expanding resource exports.

The Australian bonds plunged after the Reserve Bank of Australia (RBA) remained on hold at today’s monetary policy meeting, hinting at no further policy easing in the near-term.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, rose 1 basis point to 2.82 percent, the yield on 15-year note also nearly 1-1/2 basis points to 3.23 percent while the yield on short-term 2-year traded nearly 1/2 basis point lower at 1.84 percent by 04:20 GMT.

The RBA has left the official cash rate on hold for a sixth straight meeting on signs the economy is strengthening and business investment has picked up. The decision to maintain rates at current levels comes as the labour market, inflation and wages growth continue to stutter at the same time that growth has recovered, housing prices continue to surge and business and consumer confidence hover around multi-year highs.

Further, the central bank expects the economy to grow around 3 percent annually over the next several years on steady consumption growth and expanding resource exports.

Speaking with the BBC, before her speech to the Scottish conservative conference, the UK Prime Minister Theresa May has blasted the Scottish National Party (SNP) for their singular vision of independence. In recent days, the Scottish first minister Nicola Sturgeon has added pressure on the UK government to adopt some of her party’s recommendation in the upcoming Brexit negotiations, which includes access to the European Union single market for Scotland. She has threatened to call for another independence referendum. Last time in 2014, Scottish people rejected separation from the United Kingdom with 55-45 margin. Ms. Sturgeon has argued that then the Scottish people, who overwhelmingly voted in favor of staying in the European Union, were promised single market access.

The Prime Minister said that she is looking very closely to the proposals presented by the Scottish National Party (SNP) though Ms. Sturgeon has accused Ms. May’s government hasn’t paid the attention required. She said to the SNP and Ms. Sturgeon that politics is not a game and keeping Scotland in the UK is a personal priority for her. However, she felt short of saying whether she would grant another referendum or not.

The Japanese government bonds traded narrowly mixed Monday as investors wait to watch the super-long 30-year auction, scheduled to be held on Tuesday. Also, the fourth-quarter gross domestic product (GDP), due to be released on March 7 at 23:50GMT, is closely eyed by market participants as well.

The benchmark 10-year bond yield, which moves inversely to its price, rose 1/2 basis point to 0.08 percent, while the long-term 30-year bond yields fell nearly 1 basis point to 0.84 percent while the yield on the short-term 2-year note traded 1/2 basis point lower at -0.28 percent by 05:30 GMT.

Japan’s economy is likely to have grown faster in the fourth quarter than initially reported, as companies ramped up investment in plant and manufacturing equipment, a latest Reuters poll showed. GDP growth for the October-December quarter is expected to be upwardly revised to an annualized 1.6 percent from a preliminary 1.0 percent, according to the median estimate of 20 economists.

Separate data from the finance ministry is expected to show Japan’s current account surplus in January narrowed to 239.0 billion yen (USD2.09 billion) from JPY1.1 trillion in the previous month due to a slowdown in exports, Reuters reported.

The known unknowns of Donald Trump to keep BoC cautious today The BoC meet to set interest rates today. Little is expected at this meeting, with expectations higher for the April 12th meeting, where a new Monetary Policy Report will be released. So far the BoC has been trying to soften any market expectations of tighter policy – and in fact market pricing is quite restrained currently, just 10bp of tightening priced in over the next 12 months. While Friday’s release of 4Q16 GDP data will also add to the picture, our view is that the CAD remains vulnerable to various threats from south of the border, such as i) NAFTA renegotiation ii) the introduction of a border tax and iii) early Fed tightening. 1.3310/20 looks an important resistance level for $/CAD (already broken) and a close above it will add confidence to our 3m forecast of 1.40.

With January meeting gone, there are eight more Fed meetings scheduled ahead for this year and according to the December projection, the Fed is expected to hike rates by 25 basis points in three of them. Let’s look at the market pricing of the hikes,

March 15th meeting: Market is attaching 73 percent probability that rates will remain at 0.5-0.75 percent, and 27 percent probability that rates will be at 0.75-1.00 percent
May 3rd meeting: Market is attaching 48 percent probability that rates will remain at 0.5-0.75 percent, 43 percent probability that rates will be at 0.75-1.00 percent, and 9 percent probability that rates will be at 1.00-1.25 percent.
June 14th Meeting: Market is attaching 30 percent probability that rates will remain at 0.50-0.75 percent, 45 percent probability that rates will be at 0.75-1.00 percent, 22 percent probability that rates will be at 1.00-1.25 percent, and 3 percent probability that rates will be at 1.25-1.50 percent.
July 26th meeting: Market is attaching 25 percent probability that rates will remain at 0.50-0.75 percent, 42 percent probability that rates will be at 0.75-1.00 percent, 25 percent probability that rates will be at 1.00-1.25 percent, 7 percent probability that rates will be at 1.25-1.50 percent, and 1 percent probability that rates will be at 1.50-1.75 percent.
September 20th meeting: Market is attaching 17 percent probability that rates will remain at 0.50-0.75 percent, 37 percent probability that rates will be at 0.75-1.00 percent, 31 percent probability that rates will be at 1.00-1.25 percent, 12 percent probability that rates will be at 1.25-1.50 percent, 2.5 percent probability that rates will be at 1.50-1.75 percent, and 0.5 percent probability that rates will be at 1.75-2.00 percent.
November 1st meeting: Market is attaching 15 percent probability that rates will remain at 0.50-0.75 percent, 34 percent probability that rates will be at 0.75-1.00 percent, 32 percent probability that rates will be at 1.00-1.25 percent, 15 percent probability that rates will be at 1.25-1.50 percent, 3.5 percent probability that rates will be at 1.50-1.75 percent, and 0.5 percent probability that rates will be at 1.75-2.00 percent.
December 13th meeting: Market is attaching 6 percent probability that rates will remain at 0.50-0.75 percent, 23 percent probability that rates will be at 0.75-1.00 percent, 33 percent probability that rates will be at 1.00-1.25 percent, 24 percent probability that rates will be at 1.25-1.50 percent, 10 percent probability that rates will be at 1.50-1.75 percent, 3 percent probability that rates will be at 1.75-2.00 percent, and 1 percent probability that rates will be at 2.00-2.25 percent.

Commodities, Oil Rig Count, Copper Mine Strike

WTI speculative positioning: It has been another week where speculators have increased their net long in WTI. Over the reporting week, speculators increased their position by 23,299 lots, to leave them with a net long of 413,637 lots. This is yet another fresh record net long held by speculators. This large net long continues to see positioning risk grow.

US oil rig count: Over the week, the US oil rig count passed 600 for the first time since early October 2015. The rig count has increased by 77 since the start of 2017 and by an impressive 286 since the lows of late May 2016. At current prices, we would expect the rig count to continue trending higher.

Escondida copper mine strike: According to Bloomberg, striking workers at the Escondida copper mine will be able to hold out for more than two months. The main trade union for mine workers says that they have a contingency fund to cover strike costs, while they have also secured further funding from a credit union if needed.

Brazilian aluminium import quota: The Brazilian government has lowered the quota for duty-free primary aluminium imports. The government has reduced the quota from 240,000 tonnes to 173,000 tonnes. Reports suggest the quota was reduced as a result of poor domestic demand.

Wheat spec positioning: Over the last reporting week, specs reduced their net short in CBOT wheat by 12,662 lots, to leave them with a net short of 27,385 lots. This is the smallest net short position that specs have held since November 2015. 

EU sugar exports: The European Commission is set to vote this week on whether the second tranche of out-of-quota sugar exports is to be approved. Given a tight EU balance, the EC has held off from allowing these exports. Export licences are usually awarded in January.

European Bonds and Credit

It was quite a rollercoaster ride in Eurozone government bonds yesterday, mainly in semi core EGBs, which was in part related to thinner-than-usual liquidty due to closed US markets. Although opening tighter, semi-core EGBs soon started to underperform Bunds, and after the news that Ms Le Pen had gained some ground on her main election rivals sparked strong selling in the 3-5yr OATs, 10yr OAT/Bund spreads suddenly leapt 4-5bp to exceed 82bp for the first time since August 2012. In this context, the 2yr Schatz yield plunged to a new all time low of -0.85%, helping to push Schatz ASW to 70bp. Meanwhile, the 10yr OAT/OLO spread – one of our favourite measures of the French politcal risk premium – even briefly touched the 30bp level. Later in the afternoon – when French Finance Minister Michel Sapin warned that betting against France would be costly – OAT/OLO spreads re-tightened, although the 3-5yr area struggled to reverse the heavy underperformance  Based on recent performance trends versus Austria and Finland, DSLs still hardly suffer from any political risk discount, even though they trade cheap versus Bunds by historical standards. Against this backdrop, we find 3-5yr BNG and NEDWBK trading at very attractive spreads versus KfW. 10s30s struggled to flatten yesterday, despite the broader risk-off mood, especially after the EFSF announced the intention to launch new 4yr and 39yr lines. When the ESM launched a new 40yr bond back in 2015, the extension in ASW from the existing 30yr line amounted to around 20bp. Applying this to where the EFSF 2047’s are currently trading we would arrive at around MS +68 for the new EFSF 2056 as an indicative pricing. Adding a NIP of abound 10bp (which is slightly more than the one seen in the recent ESM 11/46 deal) to the current 9bp curve extension from the ESM 45’s into the 55’s yields a roughly similar result. Elsewhere, ECB data revealed that PSPP purchases accelerated slightly last week, to €17.2bn from €16.9bn the week before. However, total APP purchases slipped to below €20bn due to slower covered bond purchases. Even so, the ECB remains well on track for another €85bn of asset purchases for this month.

Mexican Central Bank, Inflation and Outlook

According to news reports, central bank governor Agustin Carstens will stay in his current position until the end of November 2017, as opposed to leaving at the end of June. He was set to join the BIS as General Manager on 1 October 2017. At the time of writing, neither the central bank nor the office of Mexico’s President had confirmed this delayed departure. If confirmed, the change in his departure date would give more time for the President to consider submitting an initiative to Congress to change the central bank law to remove the requirement that all members of the board have to be born in Mexico. The main beneficiary of this change would be, in our view, Alejandro Werner, current Director of the Western Hemisphere at the IMF. Results from the latest Citibanamex inflation survey will be released today at about 3:00pm EST. We estimate that headline and core consumer prices rose 0.15% mom and 0.37% mom, respectively, in the first half of February versus the second half of January. If our estimates are accurate, annual headline inflation would stand at 4.5%, down from 4.7% in January, while annual core inflation would be 4.0%, unchanged compared to last month. The government will report consumer price figures for the first half of February on Thursday at 9:00am EST. We expect annual headline inflation to remain above the central bank’s inflation target (3% ± 1p.p) upper limit throughout the year. We estimate that agricultural prices fell by close to 1% in the first half of February, relative to the second half of January, accounting for most of the gap between the headline and core inflation prints. Finally, in a TV interview central bank deputy governor Alejandro Díaz de León said that the central bank’s main job is that inflation expectations remain well-anchored and that price formation in the economy also remains adequate. In his view, the central bank’s interest rate increases are creating a more orderly outlook for inflation. He said that future interest rate increases will be contingent on several items, including relative monetary conditions vis-à-vis the US Federal Reserve, upcoming inflation numbers and the output gap. These are the main factors the central bank has mentioned in its most recent monetary policy statements. On currency interventions he said that the goal has been to foster good liquidity in the market and intervene only in a few instances when liquidity dries up.

Italy: Risk of imminent snap elections reduced

The PD party will hold a congress after Renzi’s resignation as party leader. Should the PD split, government activity could be possibly negatively affected. The publication of the motivation of the Constitutional Court ruling on the Italicum, the electoral system for the Lower House, was seen as a crucial passage towards the end of the current legislature. As a reminder, the ruling yielded a trimmed-down version of the Italicum, proportional in nature, which the Court itself reckoned already usable. The ruling of the court added that different electoral systems in the two branches of the parliament are acceptable, provided that they do not prevent the formation of “homogeneous parliamentary majorities”. As the electoral law of the Senate is also proportional in nature (with a different entry threshold and no majority bonus), most observers read the qualification of the Court’s motivation as an implicit recognition that a viable, if imperfect, electoral system is in place and ready to be used in case of snap elections. As many key actors on the political scene had been vocally pushing for snap elections, the risk of a vote in June was then seen as increasing. However, developments within the Democratic Party (PD) over the last couple of weeks have mixed up the cards. First came some statements from a couple of ministers, originally in favour of a rush to the polls, who had apparently changed their mind, and started suggesting that a better electoral law should be sought in the Parliament and that the current Gentiloni government should be given some time to complete unfinished work. The second, more powerful, turning factor was the meeting of the steering committee of the PD party, the senior party in the current government alliance, which was held last Monday. The debate, opened by Renzi as the party’s leader, highlighted once more that strong divisions between Renzi and the leftist minority persisted. During the discussion Renzi proposed that a party congress should be called soon and that this should be concluded with a primary election to nominate the new party leadership. The leftist minority refusal to accept Renzi’s candidacy as leader of the party, not to mention the imposition of any short deadline for the congress, opened the door to the possibility of a party split. The issue was tackled again during the assembly of the PD party held yesterday in Rome. Divisions were confirmed as was the scarce willingness to bridge the gap on both sides. Yesterday Renzi formally resigned from his leadership, technically paving the way to the party’s congress, whose timetable will be set tomorrow in the meeting of the steering committee. The risk of a party split now looks very high. In principle, the perspective of a PD congress held over the spring should substantially reduce the risk of a June snap national election. Should a split of the PD party actually materialise, the risk of political instability would likely increase, and PM Gentiloni’s government action could be weakened as a consequence. Not only would it be harder to assign priorities to left-over reforms (the new Gentiloni government is de facto a continuation of Renzi’s government), but chances of reaching an agreement on a parliamentary modification of the electoral law would also be reduced

FX Update- European Politics and the UK

It will be hard for markets to get away from discussing political developments in the Eurozone this year. Friday’s risk off market, driven by what appeared to be shifting probabilities for the French election, is showing just how vulnerable the EURJPY cross has become. The Japanese investor owns 12% of the French OAT market, mostly accumulated in the past 2years. This large asset position is now at risk should volatility in this EUR bond market increase. The Japanese have been net sellers of foreign bonds since the middle of January. While Japanese lifer hedge ratios for EUR assets is generally high (82% in 3Q16), the liquidation pressure and, more importantly, sentiment, will still affect FX markets, we think. The risk of EURJPY falling has increased and so we have chosen to sell as a tactical play for our trade of the week. The next support area is around 119.30.

Markets will watch efforts of the French left combining to bring one of its candidates into the 2nd round. A possible scenario of a 2nd round vote between a hard left and a hard right candidate may increase the chance of the Front National’s Le Pen becoming President. Her agenda to leave the EU and the EUR would require Parliamentary approval and hence represents an unlikely outcome. However,a potential scenario of a hard left or hard right future French President could perhaps reduce Franco-German co-operation which could potentially disrupt EMU for years, leaving the ECB in charge, which might win time by introducing a policy of prolonged period of negative real rates and yields.

The 15 March General Election in the Netherlands could increase jitters further should the outcome point towards increasing populism. Polls over the past week show a tight race, with the PVV party (Geert Wilders) only on a narrow 3-4 point ahead of the VVD party, relative to the 9 point lead seen at the start of the month. Since 8th February,3m implied volatility for EURUSD has diverged from USDCHF, which we think needs to play catch up. The SNB’s sight deposit volumes will be watched again today.

A lot of the anticipated weaker economic data in the UK appears to be in the price for GBP.Friday’s miss on retail sales (0.2%M) showed consumers may have brought forward spending ahead of anticipated price hikes, causing GBP to weaken as markets priced out some probability of a hike by the BoE this year (currently around 3bp). The impact of UK data on GBP goes as far as that. We think that it will be loose global liquidity conditions, increased political uncertainty in the Eurozone, combined with an undervalued GBP which will drive the EURGBP pair lower. The Brexit debate will continue with the FT reporting today on Michel Barnier’s (EU’s Brexit negotiator) proposal that any trade EU-UK talks be denied until progress is made on a EUR60bn exit bill, which could make progress difficult for the UK after they trigger article 50 this quarter. We think however that GBP could be driven higher as global reserve managers start to reallocate into GBP assets.

Monthly Global EM Outlook, Trump Policies and Inflation

From the current starting point, the near-term inflation outlook is generally unthreatening in most markets that have a large weight in the international benchmark indices for EM local currency debt.

Inflation has risen in some EM countries during the past half year in response to currency depreciation and increases in global oil prices; but the CPI impact of exchange rate weakness has in most cases diminished and the oil price effect is probably about to peak. Beyond the group of EM countries that now have large weights in the EM debt indices, it is notable that core inflation is on the rise in China.

 The current level of core inflation (2.2% year-on-year) is not seriously disconcerting but if it continues to creep upwards then it will eventually become a constraint on China’s monetary policy. This represents a risk for the entire EM/commodities complex, but it is more likely to be a risk for the second half of 2017 than a focal point in the next few months. More imminently, the main risk of abrupt policy rate increases in the EM universe comes from the US in the form of the possibility of a surprisingly large batch of Fed rate hikes during the remainder of the year and/or a border adjustment tax. Either of these shocks could force a swathe of EM central banks to choose between raising their policy rates substantially or having to live with undesirably steep currency depreciation.

Given the current predominantly unthreatening EM inflation trends and residual labor market capacity slack in many countries, a large share of the EM central banks – especially in Asia – look set to be able to leave their own policy interest rates unchanged if the Fed keeps raising rates at a gentle pace and if the US border adjustment tax fades away.

An important source of inflation volatility in the EM world in recent years has EM currency depreciation (in nominal trade-weighted terms) that has led to increases in prices not only for imports, but also for those domestically produced goods that compete against foreignproduced items either in the domestic market or the export market. However, this problem dissipated in most of the EM world during the course of 2016, and only a few of the large EM countries – Mexico and Turkey to be precise – are seeing this problem unfold right now

Two other large EM countries – Brazil and Russia – are in the opposite camp. Inflation has fallen sharply in both countries in the past year. This reflects in part a swing from large-scale currency depreciation in late 2015 and early 2016 to equally forceful currency appreciation during the past 12 months. Deep recession, widening output gaps, and cautious monetary policy in both countries have also helped contain inflation. The view of our Brazil-based economists is that recent currency appreciation will continue to help drive down the country’s inflation in the present year whereas the main drivers of last year’s fall in inflation were a large decline in the pace of adjustment in government controlled prices (in part reflecting currency dynamics and a big change in global oil price inflation), the depth of the recession and, related to this, weakened wage pressure in the labor market.

To be sure, the behavior of EM currencies, inflation and policy rates would be highly likely to become much messier if the Fed were to accelerate the pace of its rate hikes substantially beyond what is currently priced into the US rates curve, perhaps in response to stronger wage data or aggressive future plans for unfunded US tax cuts. There is also, in our view, a very real risk to EM investors associated with the plan of Republican members of US Congress for border adjustment taxation (BAT), or from the possible imposition by the US of other types of import taxation. As we have argued multiple times on these pages, the BAT and import tariffs are likely to be highly dollarsupportive. If Trump’s decides to support either, and if he secures congressional approval, dollar-based holders of EM local-currency-denominated assets are likely to take a hit.

It might seem inviting to think that the BAT would help curb inflation in the EM world, because it would be likely to drive down the dollar price that EM-based importers pay for goods from the US (as US exporters would be entitled to a new subsidy) while also driving down the dollar price that EM-based exporters would obtain from sales to the US (because their sales would be subject to taxation at the US border). But the inflation “benefit” would be eroded by EM currency depreciation against the dollar. EM currency depreciation would most likely be sufficient to drive the local-currency prices for EM countries’ exports and imports (in trade with the US) almost all the way back to their pre-BAT levels.

 

Carry Trade outlook, VIX lower and risk assets higher, Yellen keeps March alive

Selling EUR and JPY vs EM. As the VIX is approaching the lows again, and with iron ore prices bursting 10% higher over recent days, we continue to see risk currencies performing well, particularly vs the EUR. The drivers of risk support are emanating from the DM world, as China’s monetary conditions are tightening. After Yellen only marginally changed market pricing for hikes this year (52bp to 55bp), the sweet spot of low US real yields, with rising growth expectations, remains, helpinghigh yielding EM currencies to outperform. Our own portfolio includes long MXN, TRY and INR. Even Australia’s data is outperforming, with consumer and business confidence rising. Today’s US retail sales data are expected to be strong on the control group measure. While the USD has become less sensitive to US economic surprises, the data point will still add to the long term picture of an economy that is closing its output gap and so could see higher inflation down the line if companies increase capital expenditure.

China is tightening monetary conditions. New CNY loans grew in January (CNY2.03trn) but were lower than market expectations after the Jan 24 10bp rise in the Medium-term LendingFacility (MLF). The gap between M1 and M2growth has also narrowed for a seventh consecutive month to 3.2% last month from 10.1% in December. The result appeared in property sales data which slowed in January after tightening measures and potentially the Chinese New Year holiday. Data from local housing developers shows that average weekly property sales by area in Tier 1 cities in January fell more than 30%Y and more than 10% week over week. Shanghai and Shenzhen fell even more, according to the China Index Academy.

Cash ready to buy risk. The global impact of China’s tightening of monetary standards may not be seen in FX markets straight away as it is masked by still expanding balance sheets at the ECB and BoJ, rising commodity prices helping growth and now a newly developing point, cash ready to be deployed into assets. The FT is reporting on Swiss banks seeing increasing questions from private wealth on where they can invest cash in a rising inflation environment. Surveys among affluent US investors show they held 28% of their portfolios in cash in 2015,up from 25% the year before. Cash holdings in Europe and Asia are much higher at 40% and 37% respectively. The EUR may weaken in this environment as political risks may increase caution in investment into this region. EURGBP is about to break below its 200DMA at 0.8455.

Yellen did little to change our outlook on the USD, so staying positive vs the low yielding G10 and seeing high yield EM outperforming. The market is now pricing 55bp of hikes this year, including 6bp for March. Interestingly, historical G10 currency sensitivity to US front end yields played out exactly with the JPY and NZD under-performing, while GBP stayed flat. There was perhaps a hawkish tilt to the speech, with our economists noting that Yellen didn’t want to send a signal for a March hike by saying they will assess at upcoming “meetings” rather than “meeting”. Reiterating the FOMC’s stance that they will incorporate fiscal policy when details become more evident was a clear sign that the Fed, like the markets, will be waiting for details on Trump’s tax plans expected in coming weeks. Trump’s meetings and interactions with world leaders over recent days appear to be risk supportive as there has been less emphasis on increasing trade tensions. On the politics front, market focus may now turn to the G10 foreign ministers meetings in Bonn on Thursday and Friday. Market is long SEK. On Monday we outlined some scenarios on the details to watch for in today’s Riksbank Monetary Policy Statement (Krona and repo path). Since we think neither of the “hawkish” surprises are likely and that the market appears to be long SEK into the meeting, we worry that there could be a shock in store that would weaken SEK as markets unwind. We are not however saying that the Riksbank isn’t going to be optimistic, just that markets appear to be getting ahead of themselves, with the setup appearing to be very familiar to those who watched the RBNZ recently too. Swedish data may have improved but the fact that the SEK is now at the Riksbank’s year end forecast, the likelihood that enough members propose a rate hike sooner than mid-18 is low. EURSEK should see support around the 9.41 low and resistance around 9.50.

European Bonds and Credit, spread tightening across the board

Yesterday saw some semi-core and peripheral spreads tightening pretty much across the board versus core EGBs, with especially PGBs putting in a strong performance, outperforming 10yr Bunds by more than 10bp. GGBs bucked the tightening trend after ECB’s Stournaras told Greek MPs that the bailout was at a “critical” stage, and that any future PSPP-eligibility of GGBs would be contingent on the completion of the bailout review and a legally binding agreement over specified medium-term debt relief measures (which doesn’t seem imminent to say the least).

A remarkable feature of yesterday’s price action was the further widening of Bund ASW spreads, with the futures-implied 10yr Bund ASW hitting 50bp. It now exceeds our estimate of fair value – which is based off 2s10s, BTP/Bund spreads, 6M Libor-repo spreads and implied volatility – by more than 10bp. ECB weekly data on PSPP showed that purchases slowed marginally to €16.9bn in the week ended 10 February from €17.3bn the week before.

Corporate and covered bond purchases also slowed, but the overall €20.1bn bought across all asset classes still leaves the ECB on track to buy more than €80bn in February. Today’s main event will be Fed Chair Yellen’s testimony to the Senate Banking Panel. If she want’s March to be a live meeting as other Fed officials have suggested it is, she will have to adopt a more hawkish tone beyond the usual reference to data dependency. Currently we calculate a market implied probability of around 17% for March rate hike. Supply. No EGB supply is scheduled for today.

In SSA space KfW has used this opportunity to announce the launch of a new 10yr KfW EUR benchmark. Wide Bund ASWs currently render the agency relatively cheap versus the sovereign. The KfW 3/26 which was launched last year currently trades at a pick-up of 30bp versus the DBR 2/26 – its widest level to date. We think these levels are starting to look attractive for switches into KfW. Not only do our models for the Bund ASW suggest that it is currently much too wide but we also think that the Bundesbank is at the point where it has to increasingly look into the option of sub-depo buying – and also agency- or regional bond alternatives to Bunds.

Chair Yellen and Rate Outook for the USD

Chair Yellen may opt to play it cool at today’s semi-annual testimony to the Senate (1500 GMT), but with markets pricing in just a 30-35% chance of a March rate hike, we see limited downside risks to the dollar if the status quo is retained. The Fed chief may alternatively look to nudge expectations up to 50:50 in a bid to keep the option of a March hike on the table. Here’s our take on the hot topics: ? Prospects of a March hike: She is most likely to keep her options open, reiterating that all meetings are “live” and decisions are “data-dependent”.

Working down the Fed’s Balance Sheet: The Fed has said that it would consider stopping reinvestment of maturing assets when tightening is “well underway”. ? Trump and Fiscal policy: This is still very uncertain. Her easiest dodge would be to say that it is impossible to judge how the Fed would react without knowing the finer details, though Republicans may push back by saying this could be known in “2-3 weeks”. She could state that productivity-enhancing policies are better for the US.

Policy rules (eg, Taylor Rule): Favoured by some Republicans, but she’ll probably reference her latest speech which noted issues in estimating policy rule inputs.

Financial regulation – in particular Dodd-Frank: She typically says that Dodd Frank helped strengthen the financial system and should not be rolled back. She could repeat her sympathy with the notion that it is too onerous for smaller banks.

Foreign dumping of Treasuries: This is an old favourite and senators like to cite large overseas holdings of US Treasuries as a risk. Yellen will aim to stay apolitical.