Friday, February 5, 2016

Markets Reprice Fed Policy Forecasts Weekly Market Update: Markets Reprice Fed Policy Forecasts
Fri, 05 Feb 2016 16:09 PM EST

After two weeks of moves sideways or higher, most global equity markets resumed the downtrend seen in early January. The big exception was the suspiciously calm Shanghai Composite, which eked out a modest gain ahead of China's Lunar New Year holiday week and was much less volatile than in recent weeks. With central bank largess pacifying most of Europe and Asia, concern about the US played a central role. The dollar saw its biggest weekly decline against the index since 2009, while US treasuries rallied and the 10-year UST yield sank as low as 1.790% on Wednesday, its lowest level since last February and within half a percentage point of the record low of 1.380% seen in 2012. Analysts reoriented their forecasts on Fed policy moves, with many suggesting only one or two rate hikes may be possible this year. Lower interest rates slammed US banks, as shares of a raft of major US financials hit 52-week lows. Commodity prices broadly lifted outside of energy, on the outlook for lower rates allowing the beaten down global materials stocks to enjoy a modest rebound. Gold moved back above the 200-day moving average for the first time since November while the mining stocks saw big outperformance. Weak earnings results from many oil and tech names provided no relief and for the week the DJIA lost 1.6%, the S&P fell 1.3%, and the Nasdaq plunged 5.4%.

Markets recalibrated their outlook for Fed monetary policy this week, helping to weaken the greenback. In a note published on Tuesday, Goldman Sachs pushed its forecast for the next Fed interest rate hike out to June from March, and lowered its view for the number of increases this year to three from four. On Wednesday, New York Fed Governor Dudley acknowledged that conditions were worse now than they were in December when the FOMC delivered its first rate hike, but also stated the FOMC was not ready to draw very many conclusions about policy right now. Dudley's cautious comments about the strong dollar also helped momentum. The closely-watched dollar index fell more than 3% on the week and gave up all its gains since late October. EUR/USD climbed more than three big figures on the week - rising from 1.0850 to around 1.1200 - putting the dollar at its weakest level against the euro since last fall, when the ECB began hinting about additional QE measures and tanked the single currency.

Key US January data raised tough questions about the state of the domestic economy. The ISM manufacturing PMI remained in contraction territory for the third month in row, while the employment component dropped to its lowest level since June 2009 (45.9 vs 48.0). Services PMIs deteriorated, with the Markit reading dropping to its lowest point in the series in 27 months and the ISM data at its weakest since March 2014. The January US jobs report was a mixed bag: the nonfarm figure was +151K, well below expectations and the weakest total since the +149K gain in September, while the December nonfarm figure was revised down by 10% to 262K. On the other hand, unemployment declined to 4.9%, pushing the economy even closer to full employment. Hourly earnings were materially higher, giving the Fed some of the wage inflation it has been looking for.

Global interest rates descended after the Bank of Japan's move to negative interest rates late last week. Two-year yields fell to -0.5% in Germany and -0.2% in Japan, where the 10-year yield touched 0.025%. The sugar high felt by the yen wore off quickly, as USD/JPY dropped back to the 116-118 area it had been occupying in the weeks leading up to the BoJ decision, off the 121.50 area. BoJ Governor Kuroda spoke extensively about last week's decision, stating that just because negative rates were adopted it does not mean the bank is out of ammunition to expand asset buying. Kuroda said he is still concerned that inflation expectations will weaken in medium term, but for now saw the economy recovering moderately. He reiterated the BoJ is prepared to push further into negative rates, if necessary.

Crude prices were volatile this week, and despite the snapback on dollar weakness remained below last week's highs. Coming into the week, prices dipped on the weak China manufacturing numbers and a round of denials that an emergency OPEC meeting would be taking place. WTI sank around 11% to below $29.50 and Brent dropped 10% to $32.30 on Monday and Tuesday as hopes for coordinated production cuts were crushed. OPEC and Russia January production reports showed modest growth in output, further pressuring prices. Russia pumped the equivalent of 18.9M bpd, +1.5% y/y, a post-Soviet record. The plummeting dollar revived prices briefly, but both contracts were well off their highs as the week drew to a close, with Brent around $34/bbland WTI below $31/bbl.

After the market volatility last August and this January, China's FX reserve levels have become a point of concern for broader markets. The December data showed the biggest monthly decline on record in Chinese reserves. For 2015 overall, reserved declined $513B, the biggest annual drop ever. The January report drops over the weekend, and expectations are for another record drop by more than $100 billion, to a total of $3.2 trillion. While this number is almost unimaginably huge, some analysts suggested that markets would start to worry if the total dropped to $2.8 billion or less, as the PBoC could be forced to let the yuan slide lower with dramatic consequences. Needless to say, the softer dollar gave the Chinese breathing room in their struggle to manage the yuan this week.

The BoE's Monetary Policy Committee returned to unanimity for the first time since last July, voting 9-0 to keep interest rates on hold at record lows. McCafferty, the MPC's only real hawk, switched his vote to the majority and conceded to the data, noting that the pick-up in wage growth has been more muted than expected. And while the committee also cut its economic growth outlook over global growth concerns, it also stated that a rate hike would be more likely than not over the forecast period. At his press conference, Governor Carney said the committee did not discuss negative interest rates and reiterated that the whole MPC believes the next rate move likely higher, not lower. Cable leaped to one-month highs after the decision, testing briefly above 1.4650 before dropping to 1.4470 on Friday.

The Q4 earnings season is in full bloom but results have not been a boon for the equity markets. Results in the tech sector included some notable disappointments. GoPro sales bombed during the holiday quarter and guidance was even worse as management said they would need the next quarter to clear out excess inventory. Executives promised a simplified product line and a focus on developing better software would improve the user experience and future results. Renewing a commitment to long term thinking, they also said they would no longer give quarterly guidance. Yahoo reported another lackluster quarter, and CEO Meyer announced her latest underwhelming turnaround plan. She confirmed reports that the board would review alternatives for the core internet business, but gave every indication that she is not in favor of the idea. On Friday, shares of LinkedIn traded down 40% after earnings and very weak guidance caused analysts reconsider their valuation of the stock.

Among the most notable earnings out this week were results from the global oil majors. BP's fourth-quarter earnings plunged 91% y/y, with its key "underlying replacement cost profit" metric falling to $196 million from $2.2 billion. For 2015, BP saw an annual loss of $5.2 billion compared with a profit of $8.1 billion a year earlier, worse than the $4.9 billion loss in 2010, when BP was battered with write-downs and charges related to the Gulf oil spill. Exxon's quarterly results were better than expected, although profits fell more than 50% y/y and revenue was down sharply. ConocoPhillips bent under balance sheet pressure, slashing its dividend by 66% after its net losses steepened dramatically on a y/y basis. Royal Dutch Shell saw its profits cut in half y/y, while revenue fell slightly less than 50%, although its preliminary report two weeks ago prepared markets for the slump. Norway's Statoil saw profits shrink 44% y/y.

In deal news, Abbott agreed to pay $56/share in cash to acquire over-the-counter testing kit firm, Alere. The offer represented a huge premium of more than 50% over Alere's prior closing stock price. The total deal is valued around $5.8 billion. Just two weeks after News Corp quashed rumors it was pursuing Twitter, new reports circulated that private equity firms were working on a deal to take Twitter private. Six months after Syngenta said no to a $47 billion takeover attempt from Monsanto, the Swiss ag firm has said yes to a $43 billion offer from state-owned China National Chemical Corporation. The transaction would be the largest acquisition of a foreign company by a Chinese business and the latest in a string of deals by the company, known as ChemChina.