Allusion of Ever-Present Peril

Flippity-Flop

The highlight of last week was the release of the Fed minutes from the FOMC meeting on January 28th 2015

The FOMC statement from that meeting left a hawkish impression on the market, however, the minutes showed that Fed members were much more cautious, with many members saying they were inclined to stay at zero for longer. Members expressed concern that raising interest rates too soon could pour cold water on the U.S. economic recovery, and fretted over the impact of dropping "patient" from the central bank's rate guidance. Members also grappled with the weakness in international markets as well as worrying about falling inflation expectations in the U.S.

The flippity-flop in terms of the perception of the Fed’s first interest rate increase has had a hand in sidelining the USD as of late. The market will now look towards Fed Chair Janet Yellen’s testimony before Congress next week for insight into what the Fed is thinking. If Yellen comes across as hawkish then the market will expect a rate hike at the June meeting. However, if Yellen takes pains to explain the risks from a prolonged decline in inflation and the uncertainty in the international outlook then the uncertainty in the Fed’s first interest rate hike will continue to dog the USD.

Sword of Damocles

 

Finance ministers from the 19 countries comprising the Euro group has granted Greece a critical 4-month extension to its massive debt bailout so that officials can work out a longer term deal thereby prolonging the state of looming disaster for the shaky economic union. After trading many jabs and insults, it is safe to say that the easy parts of the negotiations are over. The deal won’t go into effect until the various national legislatures around Europe have approved it.

In some countries, particularly the Netherlands and Europe, this will be a tough sell. Understandably, some countries are frustrated at seeing their euros flow into a country whose economy never seems to improve.

The deal will mean that Greece will temporarily avoid going bankrupt as their financial lifeline is extended for 4 months. It should also mean that capital controls will not be needed and that Greek banks will have enough money to stock up their ATM’s. However, to get the money, the Greek government has one more hurdle to clear, which is to present a series of unspecified economic reforms measures that are deemed acceptable by creditors and rooted in Greece's previously enacted bailout agreement – something the government had promised not to do. Greece’s Prime Minister, Alexis Tsipras, now has to sell the Brussels deal and an eventual long-term agreement with the Eurozone not only to voters, but to Syriza's left wing and his junior coalition partner, the right-wing Independent Greeks.

These economic reforms should have been presented at the time of this writing. Notably, the Greek government will be the author of the reforms pursued, which has a rallying cry for the Syriza Party during Greek election campaigning. This represents a change from the past 5 years when Greece has relied on rescue money to avoid going bankrupt and was effectively ordered to enact a series of austerity measures by Berlin and Brussels.

Mixed Signals

 

 

The USD ceded some ground to the other majors this week, in spite of a late rally. As you can see from the one day relative performance table, investors were caught leaning the wrong way ahead of the week’s main data release, Friday’s non-farm January payrolls report on the US labour market. The report smashed expectations as the economy added 257K jobs, far above the 230K that was expected. In addition, the November and December reports were revised up by 147K making it the strongest three months of jobs gains in 17 years. Not to be outshined, average hourly earnings surged from last month's disappointing -0.2% to a whopping 0.5%, which was the highest monthly jump in average hourly earnings since November 2008. However, on an annual basis the increase was a less impressive 2.2%. Nevertheless, these reports restored a large amount of faith in the US economic recovery. Sentiment had been firmly against the USD since the beginning of January as U.S. economic reports were sending mixed signals about the strength of the economy and the timing of the Fed’s first interest rate hike. Doubts about the Fed’s timing arose after disappointing December average hourly earnings and retail sales. Other reports adding to the discourse was the falling employment component in both the ISM Manufacturing report and the ISM Non-Manufacturing report and the 17.6% rise in layoff announcements in the Challenger Grey & Christmas reports.

 

Friday’s very strong labour market reports have put a June rate hike by the Fed back into the picture. This will allow the Fed to drop or dilute it reference about “patience” at its March meeting, which would lay the groundwork for an interest rate hike at its next meeting in June, which incidentally also includes a press conference. On the other hand, the Fed can certainly afford to remain patient before raising interest rates, given the global deflationary backdrop, the downward pull on inflation from low oil prices and the strong USD. But before we get to the next FOMC meeting on March 18th, the USD may come under pressure ahead of the release of the January FOMC minutes on February 19th and U.S. Federal Reserve Chair Janet Yellen’s semi-annual congressional testimony on monetary policy on February 24th.

 

Before we end this Dispatch, we would like to make two short points about the euro and CAD. The euro has been going back and forth within a 2 cent range on headlines about Greece and its solvency. One of our favorite sound bites this week came in an exchange with European Parliament President Martin Schulz and Greek finance minister Yanis Varoufakis. Schulz warned that Greece risks national bankruptcy if it continues down the path of non-agreement. Varoufakis’ response was to simply restate what he had previously said that Greece is already bankrupt. What you need to understand is that this is just plain old posturing and that the real negotiation will occur in the 11th hour. Greece needs about 10bln euros by the end of the month, but even this deadline may extend for another few months. Positive headlines will cause a short squeeze in the euro while negative headlines will cause the euro to sell off.