FOMC: is it time to drop "considerable time"?

FX

The FOMC should end bond purchase tapering today and it is likely that it keeps its ‘pledge’ to hold rates low for a “considerable time”. Previously it had argued that rates would be kept low for a considerable time after tapering had finished. Now that tapering is likely to come to an end at this meeting, the Fed seems to face a choice. It could try to anchor this “considerable time” pledge to something else. It could make the pledge unconditional, or it might decide to change the wording completely. Steve Barrow (our G10 FIC Strategist) thinks that it will probably be left unconditional. More than three quarters of analysts polled by Bloomberg anticipate that the considerable time wording will be maintained. Steve points out that the last time the Fed readied the market for a tightening cycle, it removed the “considerable period” pledge in January 2004 and hiked rates six months later. If Fed officials today are thinking in terms of a similar sort of path, we might expect members to make the same change at the December meeting to the one that it did in January 2004, which was to replace the considerable period pledge with one of “patience”. Given that the Fed seems to be treading as carefully as possible, and given that the 2004 rate-hike cycle might act as a reasonable template, a switch in language at the December meeting would seem to be favourite. Steve thinks that, if this script plays out, with the “considerable time” pledge being retained today, to be replaced by “patience” in December, the market reaction should be relatively calm. Alternatively, of course, if the Fed departs from this script, we could see a return to the sort of volatility in financial assets that we saw in mid-October – something the Fed is likely loath to see.

US durables goods orders numbers, released yesterday, were much weaker than expected. The outcome benefited of risky assets, as it most likely increased market confidence that the Fed would not indicate a faster than anticipated “liftoff” in today’s post-FOMC meeting statement. The headline durable goods orders figure for September came in at -1.3% m/m, far short of the +0.5% m/m than had been expected (Bloomberg consensus). This was largely due to a 16.1% m/m decline in commercial aircraft orders although, excluding transportation, core orders still fell -0.2% m/m (Bloomberg consensus: +0.5% m/m), a sharp drop compared to August’s +0.7% m/m increase. Capital Economics points out that a -1.7% m/m drop in non-defense capital goods orders (excluding aircraft) does not bode well business investment growth in Q4:14.

Although the FOMC meeting will obviously steal the limelight today, the ECB’s bank lending survey might also garner some interest. There’s been a lot of focus on Eurozone banks recently, what with the AQR and stress tests results released over the weekend. The ECB will hope that the clean bill of health for over 100 of the 130 banks tested will throw off the shackles and see them increase their lending. According to Steve, the key question is whether weak lending is a function of tight loan standards or weak demand (or both). Today’s survey may throw some light on this, even though Steve is pretty sure it won’t be a market-mover.

M3 grew 7.9% y/y in September, a notable acceleration from August’s 6.4% y/y increase, and much stronger than consensus expectations for 6.5% growth. A m/m push in M3 was mainly due to a surge in net foreign assets, due – in turn – to valuation effects of sharp rand depreciation, especially against the dollar over the month. This perhaps reflected asymmetry between the (larger) amount of foreign assets denominated in foreign currency versus the amount of foreign liabilities denominated in foreign currency. Growth in credit extended to the private sector also came in higher than the market had anticipated, but only slightly. It registered at 8.7% y/y against a consensus forecast of 8.6%. This represented a slight deceleration against growth of 8.8% seen in August. Helped by a lower base (it rose by an unadjusted 0.2% m/m in September 2013), credit extended to households improved marginally in y/y terms, growing 3.7% in September compared with 3.6% in August. Y/Y growth rates in lending to households will likely not continue to decelerate in a straight line from month to month, given a falling base. However, we do expect the broad bias will stay downwards, given signs of consumer stress, especially at the lower end of the income spectrum; still high levels of household indebtedness (versus long-term averages at least), decelerating growth of disposable incomes, and regulatory and debt rating constraints on banks’ appetite for lending, in particular to households; and rising interest rates. Y/Y growth of credit extended by banks to corporates fell moderately to 14.3% from 14.6% in August. The drop is unsurprising, given that the September numbers is worked off a comparatively high base (it rose by an unadjusted 1.2% m/m in September 2013). It remains to be seen whether buoyancy in lending to corporates will last, into weakening domestic consumer demand, a patchy outlook for external demand, and – once again – constraints on banks’ appetite for lending.

The rand strengthened against the US dollar yesterday, closing at USDZAR10.85, compared with Monday’s close of USDZAR10.94. Rand appreciation against the greenback occurred into a mixed to weaker performance from the dollar against the major crosses, into signs of uneven growth in the US in data published yesterday. The dollar weakened against the euro and the pound, while strengthening against the yen. Rand appreciation occurred into a mostly stronger performance from the commodity currencies we monitor for purposes of this report, and despite a mostly weaker performance from EM currencies. The rand strengthened against all of the major crosses, with the biggest move seen against the yen (1.2%). Among commodity currencies, the ZAR, NZD and AUD appreciated; the CAD depreciated, while the NOK was unchanged. Among EM currencies we follow, only the ZAR, MXN and TRY appreciated. The rand was the best-performing currency in both the commodity and EM currency categories. The rand traded between a low of USDZAR10.9808 and a high of USDZAR10.8394 intraday. Support from where the rand opened this morning sits at 10.9130, 10.8000 and 10.7500. Resistance levels sit at 11.0100, 11.1650, 11.2450 and 11.3100.

Commodity prices were stronger on the day. Copper rose by 1.0%, platinum by 0.7%, and Brent and gold both by 0.2%. The developed market MSCI rose by 1.1%, while the EM MSCI fell by 1.5%. The ALSI rose by 0.8%. The EMBI spread compressed by 9 bps and SA’s 5yr CDS spread compressed by 6 bps. The CBOE VIX index, a volatility based proxy for global risk appetite/aversion, fell by 10.3%.

Non-residents were aggressive net sellers of local equities (-ZAR1 217 million) but were even more aggressive net buyers of local bonds (ZAR2 563 million) on the day. Buying of bonds was concentrated in the longer-dated 12+ (ZAR2 371 million) and 7-12 (ZAR263 million) year segments of the curve; mild buying was also seen in the 1-3 (ZAR41 million) year segment. Selling of bonds meanwhile occurred in the 3-7 (-ZAR112 million) year bucket. Bond yields fell on the day by between 2 bps (R186 and R214) and 3 bps (R203 and R208). The 3x6, 6x9 FRAs and 12x15 fell by 2 bps, 3 bps and 5 bps respectively.

FI

The large move in the currency yesterday only resulted in a late bond rally of a couple of bps. With the currency stable overnight, it should give some early impetus to bonds. However, we expect late morning and the afternoon to be quiet, prior to this evening’s FOMC. The markets do appear to be pricing in a dovish FOMC statement.

Tuesday saw auction-boosted turnover of ZAR19.4bn. 25.4% of turnover came from the R186 and 13.9% from the R207. The three auction bonds combined for 29.6% of turnover. There was heavy offshore involvement in the auction and buying in the late afternoon. Bonds rallied by 0.5 to 3.0 bps across the curve, led by the R203 and R2023 rallying by 3.0 bps. The benchmark R186 bond rallied by 2.5 bps, while the front-end, belly and back-end of the curve all steepened slightly. FRAs followed the stronger currency, moving lower by larger amounts than bonds. The US Treasury curve bear steepened yesterday as yields rose across the curve. The 2yr UST rose by the smallest increment of 1.21 bps to a yield of 0.39% and the yield on the 5yr UST rose by 2.78 bps to 1.52%. At the longer-end, the 10yr UST rose by the largest increment of 3.55 bps to a yield of 2.30% and the 30yr note rose by 3.10 bps to a yield of 3.07%.

Non-residents were significant net buyers of nominal SAGBs yesterday for a total of +ZAR2.56bn. Foreign buying was concentrated in the 12+ year segment (+ZAR2.37bn), with net buying also recorded in the 7-12 year (due entirely to net buying in the R2023 of +ZAR263m) and 1-3 year segments. In the 12+ year segment, notable net buying was recorded in yesterday’s auction bonds: the R2030 (+ZAR956m); R2048 (+ZAR665m); and R2032 (+ZAR266m). Notable buying in this extended maturity segment was also recorded in the R186 (+ZAR465m) and the R213 (+ZAR254m); this was partially offset by net selling in the R209 (-ZAR204m). Foreigners sold -ZAR112m in the 3-7 year segment yesterday; net selling of -ZAR428m in the R208 was partially offset by net buying in the R207 of +ZAR289m.

Yesterday’s nominal government bond auction of the R2030, R2032 and R2048 saw decent bid demand. Bids fell only slightly week-on-week. Pricing was strong in the R2048 and the R2032, which cleared below market levels, while the R2030 cleared less competitively. The R2048 priced at 8.68%, 2.50 bps below its market trading level at the time of the auction, and the R2032 priced at 8.51%, 1.50 bps below. The R2030 cleared at a yield of 8.425%, 4.00 bps less competitively compared with its market level. The R2032 will become part of the ALBI as of Thursday 6 November, which could have helped demand at today’s auction. There will be only one more auction prior to bond’s inclusion. Week-on-week, bids fell to ZAR6.18bn at yesterday’s auction to record a bid/cover ratio of 2.6x; this compares with bids of ZAR6.90bn at last week’s auction (bid/cover: 2.9x). The R2032, which performed poorly at last week’s auction, attracted the majority of investor interest yesterday, with 42% of the auction’s bids going to the bond. This was followed by the R2048, which received 33% of the auction’s bids, while the R2030 received the remaining 25%. The R2030 recorded a relatively higher proportion of fully allocated bids to total bids; the R2030 received 41 participant bids, of which 23 were fully allocated, indicating weaker demand for this bond relative to the other two SAGBs on offer. This was followed by the R2032, which received 48 participant bids, allocating 10 fully. The largest interest was in the R2048, which received 38 participant bids, of which only 2 bids were fully allocated. Total auction bids rose week-on-week to 127 from 119.

EM FI markets strengthened on balance yesterday. 5yr local currency sovereign yields fell by 0.46 of bp on average and 10yr yields fell by 5.86 bps on average. SA’s 5yr yield outperformed against its EM peers, with the yield declining by 3.50 bps. This was behind stronger moves recorded in Hungary (-7.00 bps) and Mexico (-4.30 bps). In contrast, Russia (+9.63 bps), Indonesia (+1.50 bps) and Thailand (+1.00 bp) recorded the three worst moves yesterday. SA’s 10yr note fell by 3.30 bps, underperforming the EM average move. This was behind stronger moves in Brazil (-36.70 bps), Hungary (-10.00 bps) and Turkey (-9.00 bps). In this longer-dated space, the worst three moves were recorded in Russia (+7.90 bps), Indonesia (+4.40 bps) and India (+0.30 of a bp).

EM currencies generally appreciated against the USD yesterday. The exceptions were the Indonesian rupiah, which depreciated by 0.50%, the Russian ruble, which depreciated by 0.44% and the Indian rupee, which depreciated by a marginal 0.04%. In contrast, the moves stronger were led by the Brazilian real, which appreciated by 2.38%. The Turkish lira appreciated by 1.03%, followed by the SA rand (0.86%), Mexican peso (0.72%), Polish zloty (0.50%) and Hungarian forint (0.46%).

Hungary’s central bank held its monetary policy meeting yesterday, opting to leave its interest rate unchanged at 2.10%. This was in line with Bloomberg consensus forecasts. Today, Brazil’s central bank will hold its monetary policy meeting. Bloomberg consensus forecasts are penciling in an unchanged Selic rate of 11.00%.

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