- Fed wants to be data dependent and is likely to move away from forward guidance.
- Important for investors to watch core inflation.
- Market has already become more data-dependent and more volatile.
- Market expectations of pace of tightening could rise with good data.
- What does Fed policy mean for US-German 10-year spread, euro, and EMs? Read More
Next month the ECB will start implementing its QE program. Recently there have been two events that are likely to affect the impact of QE on financial markets — the resolution (albeit temporary) of the Greek situation and the seeming reluctance of large bondholders to sell sovereign bonds to the ECB. These two developments are likely to magnify the market impact of QE — the first one for peripheral securities and the second one more broadly. In the report we update our outlook on peripheral spreads and equities, broad EZ interest rates, and the euro.
As expected Yellen left the door open to all options in her testimony — she was neither dovish nor hawkish. The only thing she guaranteed is that there won’t be a rate hike in the “next couple of meetings,” which was already known. Beyond that, meaning starting at the June FOMC meeting, all options seem to be on the table. While not tipping her hand as to when rates will start going up, she said clearly that a preliminary step will be a change in forward guidance, i.e. the language that the Fed will be “patient” before raising rates. Such … Read More
Yellen testifies before the Senate Banking Committee tomorrow at 10am EST (and before the House Financial Services Committee on Wednesday at the same time). Congressional testimonies are rarely used by Fed chairs to break major news. In today’s report we review Yellen’s precedents and discuss what we expect from her testimony this week. The tone of her words, especially as they pertain to inflation, might lead the market to change its assessment of the probability of a June rate hike.
The market interpreted the FOMC minutes as very dovish, but we would be cautious with that interpretation. There are three reasons, which we discuss in today’s report, to believe the June to September timeframe remains the base case for liftoff. Overall, September is becoming somewhat more likely than it was before and June correspondingly somewhat less likely. But the most important issue remains intact: tightening is likely to proceed at a faster pace than the market expects.
• Until recently a June rate hike was far from priced in, but after the solid employment report ten days ago the market moved more than three quarters of the way there. If the market stays where it is, a potential removal of the “patient” key word at the March FOMC meeting will hardly be a surprise.
• What is not priced in is a sustained pace of rate hikes: Conditional on there being a rate hike in June, the market prices in only about a 20% chance of another rate hike in September. That’s too little when compared to current as well as past Fed thinking.
• More than to a June rate hike the market seems exposed to even a modest sequence of rate hikes. Read More
Earlier today I hosted a webinar to discuss the prospects for a resolution of the negotiations between Greece and the EZ with Plutarchos Sakellaris, former chair of the council of economic advisers to the Greek government. My base case has always been that an agreement will eventually be found. The conversation with Plutarchos has definitely not changed that view, and if anything has reinforced it. Plutarchos participated in several EU-level meetings, so it’s reassuring to hear from someone with his experience that a benign resolution is a very strong base case. I also found it interesting that Plutarchos feels that … Read More
Predictably, the finance ministers meeting yesterday did not produce any measurable result – finance ministers meetings rarely do. However, the importance of the meeting was that the two parties seem now to be genuinely negotiating. A final agreement is unlikely in the near term, but if Greece is seen as negotiating in good faith, the ECB is unlikely to pull the plug on Emergency Liquidity Assistance (ELA) access for Greek banks. ELA access effectively buys time for Greece to continue to negotiate. In today’s report we sketch out a potential compromise between Greece and the ECB. In the meantime, the … Read More
US and German yields are obviously correlated, but a close look reveals that they have declined for different reasons. In today’s report our goal is to answer two questions: What has driven the recent divergence between the two yields and is such a divergence likely to continue in the near term. Understanding what drives them is important for anticipating future moves. We decompose the US and German ten-year yields into three parts: growth expectations, inflation compensation, and term premium. We conclude that policy has been and will likely continue to be a large factor behind the relative behavior of US … Read More
- Consensus is that the euro will continue to go down, and consensus may turn out to be right, but…
- Some macro arguments as well as past experience suggest the euro may stabilize.
- How much of the euro-negative arguments are already priced in?
- A look at the yen’s experience with QE in 2013.
- EZ interest rates and other factors that argue against a sinking euro. Read More