Improving Labor versus Deteriorating Disinflation

Market Drivers October 29, 2014

Commdollars shows relative strength
Markets steady ahead of FOMC
Nikkei 1.46% Europe .01%
Oil $81/bbl
Gold $1228/oz.


Europe and Asia:
JPY Japanese Industrial Production 2.7% vs.2.3%
NZD ANZ Business Sentiment 26.5 vs. 13.4
GBP Mortgage Approvals 61K vs. 63K


North America:
USD FOMC 14:00

Currencies were quiet in Asian and early European trade today ahead of the FOMC meeting later in the day. Both euro and cable were virtually unchanged in morning London dealing while the commodity dollars were somewhat firmer with Aussie continuing to make it way towards the 8900 figure.

The economic calendar in both Asia and Europe remained nearly barren with the release of the Japanese Industrial Production data the only data point of any import. Japanse production rose by 2.7% versus 2.3% eyed and coming on the heels of better than expected Retail Sales it suggests that the Japanese economy may be seeing a rebound after six months of slowdown following the hike in sales tax.

Japan's economy is also benefiting from lower oil prices which is acting as massive cost savings for a country that must import up to 90% of its energy needs. The news helped to push the Nikkei higher by 1.46% and lifted USD/JPY above the 108.00 figure.

In Europe however all eyes are focused on the FOMC release due 1600 GMT. Although most market players do not expect any dramatic announcements from the Fed traders will pay keen attention to several key wordings in the report. The markets will watch to see if the Fed keeps the "considerable time" language in relation to its guidance of keeping interest rates near the zero bound. Additionally the markets will want to see if the Fed will continue to view the labor market as showing "significant underutilization". Lastly the markets will want to see if the Fed will alter its language regarding inflation as its 2% target has consistently fallen short of the mark.

At present the FOMC finds itself in policy dilemma as labor demand has picked up far better than projected with the unemployment rate now below the 6% mark, but inflation expectations have fallen off a cliff with 5 year breakeven signaling a 1.53% rate five years forward versus 2% just this summer.

The disinflationary tilt in the markets must be a worrying sign for the US monetary policy makers especially because the problem remains acute in both Japan and Europe and therefore threatens global demand were it to take hold in US as well. For this reason we believe the Fed will err on the side of caution and will likely emphasize the need for continued accomodation in light of low inflation readings rather than highlight the improvement in labor data.

A dovish message from the Fed could extend the anti-dollar rally in the majors and could especially help the commodity dollars such as the Aussie and the kiwi which will likely see fresh inflows capital for carry trades if the Fed signals that US rates will remain zero bound for the foreseeable future.