The eco calendar is thin

Rates

Yesterday, global core bonds continued trading in a small range ahead of the FOMC meeting. Tiny gains during European dealings were erased as Russian president Putin said he had no intention of taking other regions in Ukraine. The German yield curve ended virtually unchanged, whereas the US curve shifted around 1 to 2 bps lower. On EMU bond markets, the 10-yr yield spread narrowed 1 bp for semi-core and peripherals Italy and Spain. Greece and Portugal outperformed quite sharply with 10-yr yield spreads down 20 and 10 bps respectively. Athens reached an agreement with the Troika that paves the way for the next bailout tranche and the Greek Pireaus bank made its return to bond markets.

Today, the focus will be on the FOMC meeting. The eco calendar is thin, both in the US and Europe with only EMU construction output and Q4 labour costs, which are no market movers. In the UK, the BoE Minutes will be released and UK Chancellor Osborne will present the budget to parliament.

The two-day FOMC meeting ends today with the usual statement, but also new quarterly economic and rate projections. Finally, Ms. Yellen holds her first press conference as Fed chairwoman. So, markets will have enough to chew on. Fed comments over the past month suggest there is still a broad majority for a continuation of the tapering of its asset purchases. So, most likely, the statement will announce that it will lower their monthly purchases by $10B to $55B a month (from April onwards). This would keep the Fed on course to end this controversial programme by the October FOMC meeting. Regarding the description of the economy, the statement might moderate growth expectations a bit, but maybe adding that weather-related issues played a role. Anyway, the Beige book was not bad and explicitly pointed to the impact of the weather.

The forward guidance will probably be adapted as the unemployment rate is nearing the threshold of 6.5%. In the past, the statement said that rates would remain near zero at least as long as the jobless rate was above 6.5% but on the other hand specified that rates would stay near zero well past the time unemployment dropped below 6.5%. The FOMC will move away from this numerical guidance towards a more qualitative one.

This gives them more freedom to act if time would be ripe, as the economy is gradually recovery. However, the FOMC will be cautious as it doesn’t want to give the message it has brought forward the lift-off date. We are curious how Yellen will do this. She should signal that rates will still remain low for long. The new eco and rate projections are a key ingredient, as the outlook drives policy action. So changes to the projections might be translated in market changes to express the expected date of the start of monetary tightening. Given recent data, the FOMC may again downgrade their expectations for unemployment rate which was put at 6.3%-to-6.6% for Q4 2014 and at 5.8% to 6.1% for Q4 2015. Projections for growth and inflation will probably be little changed, but should the inflation number be downgraded, it would give a strong signal that risks are for rates to stay low for longer. The FOMC interest rate projections are key. In December 12 governors put the lift-off date for rates in 2015, 2 in 2014 and 3 in 2016. Their expectations for the end-of-2015 and 2016 median Fed Funds rate was 0.75% and 1.75%. Changes in these projections will help shape the market reaction. Finally, Ms. Yellen may give valuable insights during her press conference. She is in favour of transparency and thus expectations are high that she will answer straightforward to questions.

This morning, Asian equity markets are mixed. Chinese equities underperform as the collapse of a private developer spurred concern that the industry may face defaults. Japanese stocks performed better despite weaker trade balance data, but lost some of their appeal as BoJ governor Koruda was less soft than expected when he spoke at the end of Asian trading. The US Note future or USD/JPY give no specific indication for risk sentiment, suggesting a neutral opening of the Bund.

Today, the countdown to the FOMC verdict and Yellen conference continues (see above). Ahead of this event, trading will be thin especially given the empty eco calendar in EMU and the US. Ukraine remains a wildcard. Given that the Fed will again downwardly adjust its QE tapering pace (from $65B to $55B/month), there’s no real push to drive yields even lower even when one considers a possible change in forward guidance (cf. BoE?). Lower inflation forecasts are a risk factor. Governors rate projections or changes to forecasts could also be sensitive for markets if they would point towards an earlier or later kick-off date for raising rates than currently discounted (Oct2015). Nevertheless, overall we don’t expect a major impact on bond market. The US 10-yr yield will remain within the 2.6%-2.8% trading band (US Note future between 123-10+ and 125-06+).