Pound Suffers, EUR Contained, BoC Next

Wednesday December 7: Five things the markets are talking about

The markets focus now switches to monetary policy with today’s Bank of Canada (BoC) and tomorrows ECB rate announcement. With the market expected to hang on every word from the respective Governors, Poloz and Draghi, investors are sure to see asset price movement that will threaten the current consolidated ranges.

Last weekend’s Italian referendum result strengthens the case for President Draghi at the ECB to extend their QE program. Investors expects an extension announcement by six-months at +€80B per month at tomorrow’s monetary policy meeting (07:45 EST).

There is a lot of pressure on Euro policy officials to get their communication spot on. With the market hanging on every word of Draghi’s, he cannot afford to dither, as that would spell trouble for Italian banks and the bond market in general.

BoC’s Poloz said last week that evidence so far suggests the economy is on track to reach full capacity in mid-2018, with the services sector now expected to lead the recovery. Many expect Canada’s policy makers will leave the key rate at its current +0.5% level this morning (10:00am EST) amid higher oil prices and signs that the economy is improving.

1. Global indices in the ‘black’

Optimism that the ECB will extend its stimulus program has encouraged equity gains this week, particularly in so-called peripheral markets perceived as riskier.

Continuing the theme stateside, Asian bourses followed suit.

MSCI’s broadest index of Asia-Pacific shares ex-Japan rallied +0.25% overnight, while Japan’s Nikkei ended +0.7% higher on a weaker yen (¥114.00). Australia’s S&P/ASX 200 ended +0.9% higher, even though the Aussies recorded their first negative quarter of economic growth in five-years (Q3 -0.5% vs. -0.1% e). Korea’s Kospi added +0.1% and Hong Kong’s Hang Seng +0.5%.

In Europe, in early trade the Stoxx has climbed +1.0% and is poised for its biggest three-day rally since the U.S. election. With Italy said to be planning to take a +€2B controlling stake in Monte dei Paschi (worlds oldest bank) is supporting financials. Commodity and mining stocks in the FTSE 100 are trading mixed.

U.S futures are set to open up small +0.1%.

Indices: Stoxx50 +1.0% at 3,135, FTSE +1.3% at 6,870, DAX +1.4% at 10,926, CAC-40 +1.0% at 4,680, IBEX-35 +0.3% at 8,918, FTSE MIB +1.0% at 17,942, SMI +0.6% at 7,961, S&P 500 Futures +0.1%.

2. Crude under pressure from uptick in production

Oil prices have extended their losses, a second consecutive session since November’s OPEC agreement to cut output.

Data this week showing record high production in the producer group is supporting investor and dealer doubts that producers would be able to reduce supplies.

Brent crude oil futures are trading at +$53.64 per barrel, down -30c from yesterday’s close. WTI dropped -0.3% to +$50.76 per barrel, but is still up more than +11% from just before the OPEC production cut.

Dealers will take direction from today’s EIA report at 10:30 EST.

Spot gold continues to drift lower ($1,164), weighed down by a stronger dollar and expectations of a more hawkish Fed. Prices for the yellow metal have also been hit by concerns that a stronger U.S. economy will prompt U.S policy makers to back up rates at a faster clip in H1, 2017 (investors have assigned a +94.9% probability of a rate increase on Dec 14, and +23% of an additional increase by next May).

3. Fixed Income selling is slowing

The pace of selling is slowing down in the bond market following the biggest four-week selloff in seven-years. The Trump “reflation” selloff has shifted Tier 1 yield curves, and this despite their respected monetary policies.

Stateside, after hitting a 17-month high of +2.492% last week, the yield on the benchmark 10’s has fallen to +2.392% ahead of the today’s open.

In Europe, with investors looking ahead to ECB decision tomorrow and expecting them to announce an extension to its bond-buying program is having an impact on debt prices.

Euro peripheral prices are rising, building on yesterday’s gains, with the gap in yield narrowing to German bunds. The spread over Germany for Italian 10-year product has narrowed by -4bps to +156.4bps. Spreads over Portuguese, Spanish and French debt has also fallen.

4. Pound suffers, EUR contained

Sterling (£1.2580) is under pressure in early trading after data this morning revealed that U.K. industrial production fell -1.3% in October m/m (well below forecasts for a rise of +0.4%).

The decline in manufacturing was most pronounced in the textiles and pharmaceuticals sectors. The slowdown suggests that U.K’s industrial sector may act as a drag on growth in Q4, despite U.K services activity (about +80% of annual output) remaining strong.

Elsewhere, the EUR (€1.0716) is little changed ahead or tomorrow’s policy meeting. The market is looking for an extension of its bond buying program for at least another six-months at the current pace of €80B a month. Depending on Draghi’s tone and delivery, the single unit is expected to come under renewed pressure. USD/JPY continues to hover around the psychological ¥114.00 handle. Export dollar sellers continue to be congregated ahead of ¥115.00.

5. A surprise “down-under”

The AUD ($0.7416) has come under pressure overnight after the resource-rich economy contracted for the first time in five-years (Q3 GDP -0.5% vs. -0.1% e), threatening the longest ongoing streak without recession in the developed world. The headline print suggests that Australia continues to have trouble transitioning away from mining to other sectors.

Digging deeper, amongst the key components, capital formation (net capital accumulation) fell for the 12th consecutive quarter at -2.7%, while consumption (over +50% of economy) saw much weaker growth of +0.3% vs. +0.8% previously.

With the Aussie government determined to preserve the country’s AAA rating going into mid-year fiscal and economic outlook budget in Jan., officials will be reluctant to implement a more aggressive fiscal stimulus package.

To date, the Reserve Bank of Australia (RBA) has been rather neutral and may write off Q3 as an anomaly. However, the pressure is on Aussie policy officials to ease, as fiscal measures are likely to remain limited for the foreseeable future.

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