Fed's Dovishness Sets Tone

The US dollar suffered losses yesterday in response to confirmation that Fed policy will remain extremely accommodative for more than another year. Those losses were extended initially extended in Asia and after a brief pause, again in Europe.  The yen is competing with the Australian dollar for the leadership roll. 

The greenback remains vulnerable to additional losses in response to the realization of the extent of the Fed’s dovishness. Consider that at $55 bln of asset purchases this month, the Federal Reserve will buy more than initially conceived when QE3+ was announced. Consider that the 100 day moving average of the effective Fed funds rate has been halved over the past year to 8 bp. Consider that some regional Fed presidents, like Chicago’s Evans, and some street economists are pushing their forecast for the first hike into 2016. 

To promote transparency, the Federal Reserve had introduced the “dot plot” of economic forecasts. The minutes underscore the concern that the results would be misconstrued. This is a Federal Reserve that has yet struggling to communicate to the market. It offers a tool and then seeks to dismiss it. As the Fed continues to taper, look for its communication to evolve over the next several meetings.

On the other hand, we would play down the significance of the inflammatory claims of a secret Fed meeting. The fact that the minutes reveal that Yellen had conducted a video call on March 4 to discuss the issues before the FOMC meeting itself speaks more to her management style than something sinister. 

The dovishness of the Federal Reserve provide the backdrop for today’s price action, there have been several other developments to note.

There are two important events in China. First, China’s March trade surplus was larger ($7.7 bln vs.consensus of $1.8 bln) than expected, but due to unexpected declines in imports (-11.3%) and exports (-6.6%). The crackdown on fraudulent trade to conceal capital flows, which seems to particularly exaggerate exports to Taiwan and Hong Kong, appears to be taking a toll on these year-over-year comparisons, excluding them, exports may have increased.

The second important development is the announcement about the “mutual market connectivity” between Hong Kong and the mainland. China announced that probably starting in about six months, foreign investors will be able to trade CNY13 bln ($2.1 bln) of mainland shares a day on the Hong Kong Exchange and mainland investors will be allowed to trade CNY10.5 bln of Hong Kong listed shares a day on the Shanghai Stock Exchange. Although Hong Kong, of course, is part of China (Special Administrative Region), these measures are seen an important part of the opening up of China’s capital markets. 

This would also seem to bode well for the MSCI decision in a few months whether to include the mainland shares in its benchmark indices. The Shanghai Composite advanced 1.3% to turn positive on the year today and near two-month highs, taking out a downtrend line from early last December. 

The Australian dollar is the strongest of the major currencies, helped by ideas that the decline in China’s exports was exaggerated and a jobs report that had positive optics. The unemployment rate fell to 5.8% from a revised 6.1% and 18.1k jobs were created compared to less than 3k the consensus forecast. The details were not, however, as strong. The decline in the unemployment rate was largely a function of the decline in the participation rate (64.7% from 64.9%). And the job's growth was a function of a 22k loss of full time jobs and a 40k rise in part-time jobs. 

The volatility of the data suggests averaging the past two months, and over this time, Australia has grown an impressive 58k full time jobs. The market has moved to price in with almost 100% confidence an RBA rate hike over the next 12-months.

The yen is rivaling the Australian dollar for leadership today. Earlier Japan reported an unexpected sharp decline in machine orders, suggesting Japanese companies began pulling back ahead of the sales tax increase. Machinery orders fell 8.8% rather than 2.6% the consensus expected after a 13.4% rise in January. The yen’s strength appears to be a function of the softness of US yields and continued short squeeze as many investors’ conviction of dramatic yen weakness this year has met the cold realities of money and risk management. 

The dollar is flirting with the gradual uptrend drawn off the early February and mid-March lows that comes in near JPY101.50 today. The mid-March lows themselves were set near JPY101.20, which is the next target and then the February low near JPY100.75. 

In Europe, the key take away is that both French and Italian industrial output figures were softer than expected. This underscores the fact that both governments are touting a new push for growth and how this will be reconciled with the EU demands for austerity are not yet clear. Although in an uncoordinated fashion, a Paris-Rome (and maybe Madrid) bloc could be coming together and, if we are right about the EU parliamentary elections, the tide in Europe may turn in the coming months.

At the same time, the Greek irony cannot be lost in observers. The Greek economy is about 25% smaller than it was 5 years ago. Its debt-to-GDP is significantly higher. It returned to the bond market today with a 5-year issue for which there were over 550 accounts bidding for the paper that is going to yield 4.95%.

There were a couple of highlights from emerging markets. Korea’s central bank left rate on hold as expected. The new central bank governor lifted the 2014 growth forecast to 4% from 3.8% (and 4.2% from 4% in 2015) This underscores expectations that the next move will be a hike. The Bank also forecast inflation will rise to 2.7% in H2 2014 from 1.3% last month. Separately, we note that the Indonesian election did not produce a clear winner, meaning that a coalition will be necessary. The stock market took the news hard, shedding almost 3.2%.