Friday, December 4, 2015

Fed Headed for Higher Rates, ECB Stays Easy, Terrorism Hits US Weekly Market Update: Fed Headed for Higher Rates, ECB Stays Easy, Terrorism Hits US
Fri, 04 Dec 2015 16:13 PM EST

Policy divergence between Europe and the United States was thrown into high relief this week. On Thursday, the ECB extended its QE bond buying program to March 2017 and cut its deposit rate further into negative territory, as President Draghi said that Europe needed more support for longer. Then on Friday, the November US jobs report beat expectations with strength seen across all categories, all but requiring the Fed to hike rates at its policy meeting in two weeks. The other major financial event was the OPEC summit, where the cartel acknowledged the reality that its prior 30M bpd production ceiling was clearly being ignored by member states. OPEC refrained from actually setting a new production ceiling, though the organization's President eventually confirmed the current production level is around 31.5M bpd. Markets were forced to digest these key events against the backdrop of a horrific terrorist attack in San Bernardino CA. In a volatile trading week, the S&P500 ended up 0.1% and the DJIA and Nasdaq each gained 0.3%.

The November US jobs report was strong, with the non-farm total of +211K beating expectations and the unemployment rate steady at a seven-year lows of 5.0%. Average hourly earnings saw additional modest gains after a big jump in October. The report was the last big data point ahead of the Fed's two-day policy meeting in two weeks. Ahead of the jobs number, Fed Chair Yellen had said the labor market's progress was healthy enough to boost confidence that the Fed may reach its 2% inflation target soon. Economists at BNP Paribas said that after Friday's report it's "all systems go" for the Fed to raise rates in December.

As expected, the ECB cut its deposit rate another tenth into negative territory, to -0.30% and expanded its QE program. The central bank extended its bond buying program by six months to March 2017 and said it would begin buying regional government bonds, expanding the range of assets it can buy. Markets were apparently disappointed that the ECB failed to boost the monthly purchase amount of €60B, but Draghi defended the measures taken as "adequate." In addition, the ECB said it would also commence reinvesting principal as bonds mature, a move that Draghi later explained would add €680 in liquidity to the system by 2019 in a speech on Friday

The ECB announcements resulted in volatile price action across a variety of asset classes as markets appeared underwhelmed after weeks of buildup into the additional stimulus measures. EUR/USD was testing seven-month lows around 1.0540 in the lead-up to the decision but quickly took out 1.0900 as Draghi rolled out the new measures during the press conference. By mid-day on Thursday, EUR/USD topped out around 1.0980, a one-month high, before trading back below 1.0900 through week's end. Interest rates popped globally with several markets experiencing the sharpest back up in yields in many years. The German 2-year yield rose some 15 basis points after the ECB announcement while UST yields climbed as well. Equities were hit hard in Europe and pressured in the US as well until the solid November employment report sent US Indices surging on Friday.

Australia's central bank kept rates unchanged for the seventh straight meeting and largely reiterated the sentiment from last month's policy statement. The RBA still sees prospects for an improvement in economic conditions having firmed, inflation consistent with the target over the next 1-2 years, and AUD currency adjusting to commodity decline. The biggest change in the language was the admission of a large decline in capital spending in the mining industry.

Global industrial production PMI data was very mixed, with China remaining weak, the US looking soft and Europe possibly doing alright. The November Chicago PMI and Dallas Fed manufacturing indices were pretty soft, with the Chicago PMI back below 50 after seeing a move higher in October. Meanwhile, the November ISM manufacturing index sank below 50 into contraction, missing expectations and falling to its lowest level since June 2009. China's official manufacturing PMI was in contraction for the fourth month in a row, and the index marked a three-year low. Further slowdown in Key components of New Export Orders and Input prices revealed continued softness of external demand and also disinflationary pressures. Euro zone, Germany and France November manufacturing PMI indices met or beat expectations and moved up from October levels.

As expected, the International Monetary Fund has added the Chinese yuan to its Special Drawing Rights (SDR) basket of currencies. The yuan joins the US dollar, UK pound, Japanese yen and the euro in the basket, marking a major step toward normalization of China's position as a leading economic power, however analysts caution that it represents the IMF's opinion about which currencies are safe for asset managers to hold. Asset managers may end up seeing the IMF's decision as mainly political. Either way, it is also an important signal that China is ready to end its strategy of rapid investment-driven catch-up growth and further work towards raising domestic consumption.

The annual OPEC summit was among the most contentious in years. Saudi Arabia is now approximately 1.5 years into its campaign to lower oil prices to crush the US shale industry and consolidate its market share, and pressure was building on the Saudis to cut output while even inside the Kingdom there was said to be disagreement about what strategy to pursue. In the lead-up to the meeting, Iran argued that a majority of OPEC members supported an output cut, but other Gulf Arab countries stood with the Saudis (at the same time, Iran was insisting it did not need permission from OPEC to increase crude production). After an extended closed door meeting on Friday, OPEC delegates emerged to say that they would leave production levels unchanged (at the "actual" 31.5M bbd level, above the prior 30M bpd ceiling). The Secretary General said that they wanted to wait and see how the market develops over the next six months as Indonesia is welcomed into OPEC and Iran begins to ramp up its oil production as sanctions are lifted. WTI crude closed out the week around the $40/bbl mark.

Brazil's vast corruption scandal - over 140 businessmen and a host of politicians have been charged with bribery and money laundering - keeps penetrating higher levels of the government. On Wednesday, Brazil's lower house initiated impeachment proceedings against President Rousseff, accusing her Treasury of repeatedly borrowing money from government banks without legislative authority, in an attempt to mask deficits - rather than outright bribery or corruption. Within a month deputies must decide whether to pass the case to the senate, which requires a two-thirds majority. Senators would then have 180 days to try the president.

The November US auto sales growth was pretty weak. General Motors and Ford both widely missed expectations: Ford sales were +0.3% (v 3.2% expected) and GM's were +1.5% (+2.9% expected). Fiat Chrysler got closer to the mark with +3% sales (v +3.2% expected). Meanwhile, Volkswagen's sales declined 25% in the month, in the wake of the emissions cheating scandal.

There were no big M&A deals this week though some may be brewing. Avon shares rose on report that it is in talks to sell its North American business to Cerberus as soon as this month. Biotech name Relypsa shares surged on Friday on an unconfirmed report that Merck may be evaluating a bid.