FOMC optimistic on growth, uncertain about inflation

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FOMC optimistic on growth, uncertain about inflation.

The FOMC meeting triggered nice movements cross markets. The US Treasury curve bull flattened, while equities tanked (though losses occurred with a 1 hour lag) and the dollar gained against the euro (before and after the release). USD/JPY strange enough didn’t react (see FX). It is difficult to bring these three movements back to a one-directional reading of the Fed-statement. Oil prices already fell $1/barrel ahead of the FOMC. We read the statement as more positive on growth and somewhat more concerned about the inflation outlook with some reservations on the possible negative impact from developments abroad. Treasuries were affected by the inflation/international concerns.

The FOMC was clearly more optimistic on growth. Economic activity is now expanding at a solid pace (previously moderate), while job growth was considered strong (previously solid). No changes on household spending (rising moderately), but the Fed added that lower oil prices are boosting purchases. More surprisingly there was no change in business fixed investment (advancing). On inflation, the Committee acknowledged that it has declined further below the objective (“largely reflecting declines in energy prices”). The FOMC also recognized that market-based measures of inflation expectations declined substantially in recent weeks, while survey-based measures remained stable. The FOMC anticipates inflation to decline further in the near future but expects inflation to rise gradually towards its target in the near term. The Committee will continue to monitor inflation developments closely.

On policy, the FOMC still judges it can remain patient in beginning to normalize its monetary stance. That means no rate increases at the next two meetings (March/April). The FOMC will also take international developments into consideration (new). Our take remains that the FOMC is gradually moving towards a lift-off in June, but is data-dependent and thus remains open to change this time frame on the basis of negative inflation developments or a renewed slowing of the economy. The market counts on January 2016 for the lift-off (fully discounted), but with some chances for a move in Nov/Dec.

The eco calendar heats up today. In January, German HICP inflation is forecast to drop into negative territory. The annual rate of inflation is expected to drop to -0.2% Y/Y, from 0.1% Y/Y in December. On a monthly basis, a strong 1.0% M/M decline is expected. Ahead of the German reading, the regional data will already give an indication. We believe that the bar is already quite low and therefore the risks for a downward surprise might be limited. M3 money supply is forecast to have increased further in December. The consensus is looking for an increase from 3.1% Y/Y to 3.5% Y/Y. More interesting will however be the lending data. Loans to households increased slightly over the previous months, but lending to non-financials continued to decline. The latest ECB bank lending survey showed an further easing in lending conditions, while also demand picked up. We look out whether this will also be visible in the lending data in the coming months. European Commission’s economic confidence stayed unchanged at 100.7 during the whole fourth quarter. For January, an increase to 101.6 is expected. We believe that the risks are for an even stronger outcome. In the US, jobless claims are forecast to drop slightly further in the week ending the 24th of January.

Today, the Italian treasury taps the on the run 5-yr BTP (€2.5-3B 1.05% Dec2019) and 10-yr BTP (€3-3.5B 2.5% Dec2024). In the run-up to the auctions, both bonds cheapened some bps in ASW-spread terms. We expect the auction to go well, supported by the ECB’s asset purchases programme. In the US, the Treasury held a terrific $26B 2-yr Note auction. Today, the treasury concludes with a $35B 5-yr Note auction and a $29B 7-yr Note auction.

Overnight, Asian stocks suffer reflecting WS weakness. The US Note future is close to the post-FOMC high, suggesting a firm opening of the Bund.
Overall, day-to-day sentiment remains bullish for core bonds.Overall, day-to-day sentiment remains bullish for core bonds.

Today the eco calendar is well-filled, but unlikely to leave a trace on markets. With ECB QE yet to start, the impact of EMU eco data in general diminishes. US eco data are second tier. Sentiment on equity markets remains a driver for core bonds with plenty of corporates reporting earning. Greece is a wildcard with the new Syriza-led coalition on collision course with Europe (foreign ministers meeting today; Greece able to block additional sanction against Russia). Greek assets are expected to continue to underperform with small contagion to other peripherals the past two days. Austrian bank Raiffaisen will slash risk-weighted assets by 20% to increase the capital buffer (exposure on Russia/Switzerland) which could lead to some underperformance of Austria in the (semi-)core. Technically, both the German (0.35%) and US (1.70%) 10-yr approach the cycle lows.

Longer term, once the ECB QE-programme begins, flows will play a very important role and will likely act as a key constraining influence on upward potential of most EMU bond yields. In the US, the FOMC meeting made clear that the Fed remains on path for a first rate hike this Summer (see higher). For now, rate markets don’t buy it. We wouldn’t preposition yet (short US Note future), but closely look for a turning point.