Modest correction ahead of FOMC meeting

Rates

Yesterday, core bonds ended little changed (Germany) to slightly lower (US) ahead of the FOMC meeting. US eco data were mixed, but had only temporary effect. If tensions in other markets weren’t that precarious, it might have been labelled as a technically correction. Mistrust is growing in various corners of the financial world. The decline of oil continued, resulting in fears for defaults in Venezuela and maybe Russia or Ukraine too. Indeed, the Ruble is really in free-fall. It lost again 10% of its value yesterday and triggered a draconic rate increase by the Russian central bank to 18% from 11.5% (repo) overnight. The Venezuela 2027 benchmark trades at 38%. However, other EM currencies are feeling the brunt too. The Turkish Lira fell to USD/TRY 2.95 from 2.75 one week ago. Erdogan’s crackdown on Turkish media was of course of no help. Indian, Indonesian and Brazilian FX weakened too. European equities lost up to 2.75% with especially Russia weighing on the stock market. Wall Street losses were more contained, but gold surprisingly lost ground too. In these circumstances, it is ever more uncertain whether the Fed effectively wants to take an additional step in its forward guidance by scrapping the “considerable” period phrase in their statement. It is, of course, always inevitable that following an extreme long period of extreme monetary policy volatility will rise and victims fall, but has the Fed the guts to ignore these tensions? Bernanke at least retreated temporarily when first announcing a phasing out of QE. In this context, core bonds could do better for longer.

Finally, US yields still rose between 1 bp (30-yr) and 5.9 bps (5-yr). The German yield curve was essentially flat in a daily perspective. On intra-EMU bond markets, 10-yr yield spreads versus Germany somewhat surprisingly given overall market stress corrected lower as well. Portuguese/Spanish and Italian spreads shed 5 to 9 bps while Greece outperformed (-33 bps). We suspect that a soft Bundesbank report and a poll showing that 90% of analysts expect QE to be introduced early next year (up from 57% previous month) played a role in the narrowing.

The euro zone eco calendar heats up today with the first estimate of the euro zone PMI’s for December and the German ZEW survey. In the US, the housing starts and building permits and Markit manufacturing PMI will be released. EU General Affairs Ministers meet in Brussels, the Fed starts its two-day FOMC meeting and the Swedish Riksbank decides on rates.

Despite improvements in several other business confidence indicators, the euro zone PMI’s weakened significantly further in November. For December however, the consensus is looking for a limited improvement in both the manufacturing and services PMI. The manufacturing PMI is forecast to show a pick-up from 50.1 to 50.5, while the services PMI is expected to rebound from 51.1 to 51.5. We believe that the risks for both are for an upward surprise after tentative signs of improvement during the month, while also cheaper oil and commodity prices might be positive for business sentiment. In Germany, the ZEW indicator is forecast to increase for a second straight month in December, from 11.5 to 20. Finally in the US, housing starts and building permits are forecast to remain mixed. For both, we believe that there might be downside risks due to unfavourable weather conditions in several regions.

Overnight, most Asian equities trade with losses. Taking into account WS losses and a disappointing HSBC Chinese manufacturing PMI (below 50!) this shouldn’t really surprise. Chinese stocks nevertheless still outperform on PBOC easing hopes. The Russian central bank raised its interest rate from 10,50% to 17% to halt the crash of the Ruble. For now the comeback of the Russian currency is rather meagre tough. The oil price stabilizes just north of $60/barrel for the Brent, but we wouldn’t take it for granted after yesterday’s dead-cat bounce. The US Note future trades marginally higher as well, reflecting some risk-off sentiment.

Today, focus on the eco calendar turns to Europe with December PMI’s and the German ZEW. We see risks for a positive surprise but don’t expect that such outcome would influence thinking on ECB policy or trigger higher EMU rates. In the US, volatile housing starts and building permits are on the agenda and this week’s main event starts: the FOMC meeting (verdict tomorrow). We thought the Fed could drop the “considerable time” phrase (keeping the door for a Summer rate hike open), while leaving the “dots” roughly unchanged. Some questions linked to market stress recently arose whether the Fed has the stamina to change its forward guidance now in thin end-of-year markets. However whatever they decide, short-term safe haven flows might dominate in case the crash in EM FX/oil/equities continues. For German rates, we expect only small spill-over effects from eventual higher US rates. At least until the day that the ECB effectively walks the QE talk, we think there is very little upward potential. For intra-EMU bond markets, contagion risks (Greek political gamble, higher volatility) increased which could lead to some spread widening (PIIGS) despite an anticipated sovereign QE-programme.