Fed Lift Off in 2017

It’s March 2017, and the Trump rally still has not shown any signs of slowing. Despite a lacklustre address to congress, in which he was once again light on policy, equity markets continued to push record highs, with the Dow topping 21k for the first time ever.

Elsewhere the dollar has also rallied. It’s unclear how this will play out, given President Trump’s dislike for the strong dollar, but as it stands, a rate hike during the Fed’s march meeting is not just in play, but almost a necessity.

As yields have risen, the price of the US 10 Year has tumbled.

 

T Notes Price Action 2017
T Notes Price Action 2017

Source: tradingview.com

 

Studying the price of the US 10 Year Treasury Note, gives you a good feel for the markets relationship with the Fed and risk in 2017.

Prices rallied initially, as the brakes were put on future rate hikes. Price oscillated around 125’00 for some time, and generally remained buoyant above the 123’20 handle.

As the potential for further rate hikes seemed to ease, and the dollar weakened with commentary from members of the Trump cabinet, T-Note prices finally broke above 125’00, eventually hitting a high for 2017.

Some of the more technically minded may see the second high as part of a double top. This very well could be the case, as the technical have coincided with some strong fundamentals. As the economic data for the US continues to print strongly, and equities continue to run with the Trump trade, the Fed have stepped up their hawkish rhetoric.

The result has seen traders piling into the dollar to price in a March rate hike.

With 10 Year yields currently 2.45%, the prospect of another increase may not yet cause long equities traders to jump ship. But the Fed seem to be positioning themselves for the year ahead, which may yet continue to over deliver on inflation – particularly in the US.

Whether or not equities can continue as they are remains to be seen, as at some point, the rally will need to correct itself. But for now, short on the US 10 Year seems like a strong play, but as always, it will be essential to watch the data points and Fed speakers.

Is Brexit Beginning to Bite?

It’s 09:30 on a Friday morning in the United Kingdom, and possibly for the 1 billionth time this hour, the word Brexit has been mentioned again.

8 months since the vote to leave the EU, and the markets still cannot decide what the fundamental picture is for the UK.

On the face of it, the economic data points have been reinforcing of the concept of a resilient Sterling, attracting overseas custom with its devalued currency. Inflation was expected to rise, and with it, the oncoming of increased interest rates from the BOE.

However two factors have stayed that point of view this week. Firstly, last week inflation figures for January arrived somewhat below expectation. A CPI increase of 1.8% was indeed the highest since 2014… but it was below the analysts’ expectations.  At the time, this didn’t matter too much as markets were still in thrall of the ongoing opera that is The Donald.

UK inflation January 2017
UK inflation January 2017

 

However retail sales figures from this morning start to change the context of the recent CPI data, with data from the Office of National Statistics showing that retail sales figures had fallen in January by 0.3% vs. the expected gain of 0.9% – this coming in the light of a fall of 2.1% in December.

UK Retail Sales January 2017
UK Retail Sales January 2017

 

What these 2 charts show in terms of data is that inflation is increasing, and overall, consumers are not consuming.

This could be a dangerous cocktail for the UK economy. No further evidence of that is needed than in the Sterling Futures contract. Where cable saw a massive repricing just before the data. Falling from $1.2513 to $1.2392 by the time the data had cleared.

 

Sterling Price Action 17 February 2017
Sterling Price Action 17 February 2017

Source: tradingview.com

 

For a while it seemed Cable could have shaken off its sensitivity for at least the short term, but reactions like this show just how vulnerable the currency is to speculation surrounding the outcome of Brexit.

On a day where Tony Blair has also resurfaced to lead the pro EU fight, the dark clouds of uncertainty have begun to gather once again over the UK and it’s currency.

 

 

 

 

Has Draghi Saved the Eurozone? 

With Mario Draghi announcing a growing confidence the Euro area’s prospects, the Euro currency didn’t exactly follow suit. Since last week the single currency has fallen from $1.08440 to near $1.06500 at the time of writing.

 

 

Euro Price Action 7 Feb 2017
Euro Price Action 7 Feb 2017

Source: tradingview.com

 

Clearly, traders had priced in the potential for a much larger tapering announcement at this meeting. However, the sell-off hasn’t diminished the Eurozone’s appeal this year.

The ECB will cut its bond-buying from 80 billion to 60 billion in April 2017, and seek to extend this program until he end of the year.

Traders have clearly reacted to Draghi’s concern that the current trend in inflation is highly correlated with the increase in energy prices, and that monetary policy may still be needed for support. In this context, the current euro sell off makes sense. However it could be viewed that Draghi was playing his cards close to his chest.

Amidst all the claims of currency manipulation, it cannot be argued that the current exchange rate for the Euro against the dollar is very favourable for the Eurozone. The ECB may see an opportunity here by using rhetoric to suppress the single currency just enough for a possible inflation overshoot – while starting the process of reeling in the asset purchases now. Viewed like this, Draghi has played this move very well.

 

Is This The End of The Trump Trade?

Since the November US election, global equities have broadly rallied, with the S&P and Dow Jones Industrial Average hitting record levels in the process. Dubbed the Trump Trade, heading into 2017 it seemed all one had to do was buy US equities and then sit back and watch the dollars pile in.

However, it seems only 10 days into his presidency, Trump has given long equites traders some pause for thought with his executive order banning entry to the US from 7 majority Muslim nations.

 

eMini S&P Price Action January 2017
eMini S&P Price Action January 2017

Source: tradingview.com

From the above chart, we can see just how much markets have priced in the impact of fiscal stimulus under the Trump regime with the S&P rising over 100 points since November 8 2016. However, this has all been based on the assumption that the President should be taken seriously, but not literally.

However there is growing concern that this could only be the beginning of a more isolationist approach to policy.

So far the majority of the impact seems to be limited to business with exposure to the effected countries, or large migrant workforces – airlines and technology being the so far the worst affected. Monday saw shares in Alphabet Inc trading lower by 2.48% and American Airlines down 5.64%.

But there is still a large question as to where markets go from here. As the recent moves suggest that any increase in isolationism could undo the perceived benefits of decreased regulation and fiscal spending.

Equities markets still have some way to fall before the Trump Trade can technically be called done, but it does seem like reality is now beginning to check the rampant euphoria of post-election markets.  With the S&P seemingly happy to range and await further direction from the Commander In Chief.

 

Time to Buy The Pound?

A week after PM Teresa May’s speech in which she outlined Britain’s preferred course through the Brexit negotiations, she has had an incredibly tough session in Wednesday’s PMQs.

With her hands now tied into delivering a “white paper” for parliamentary scrutiny, the nuts and bolts of Brexit will at last be laid bare.

But by no means has this been a bad thing for the pound.

With GDP expected to come in at 0.5%, as well as an uptick in Business Optimism, the UK continues to produce strong economic data. And the recent high court ruling and rhetoric surrounding Brexit continues to suggests that Britain’s divorce from the EU will be a far more civilised one.

Clearly what is being priced into the markets now is the likelihood that any plans to sever access to the single market will be rejected by parliament. How valid this view point is, remains to be seen, but for the time being, the pound is recovering.

 

Sterling Price Action 25 Jan 17
Sterling Price Action 25 Jan 17

Source: tradingview.com

 

Make no mistake, cable has fallen a lot since June 23. But this chart shows how much it has recovered since the start of the year. However, sterling is not out of the woods yet. We can see two key price resistance levels – 1.27 and 1.34.

If Cable can manage to break above 1.27, and is further supported by positive data, then we can reasonably expect 1.27 to become the next key support area possibly even by the end of the week.

Beyond that, and there is a clear path to 1.34, the high of the initial post Brexit range.

It seems, despite the Brexit shadow, this could be a goof point to start backing the bulls on the pound.

Carney’s Brexit Dilemma

“Brexit, Brexit, Brexit!” – say it’s name three times in the mirror, and hope for it to go away.

Well, that’s probably what Bank of England Governor, Mark Carney would want. More than half a year since Britain’s vote to leave the EU, and the shadow of Brexit still looms large for the UK economy and political landscape.

Carney now seems caught between Scylla and Charybdis. Widley condemned by the Remain camp for acting too soon in August 2016 to reduce the Bank of England’s base rate to 0.25%, he now stands to be accused of not reacting quick enough to the rising inflation issue.

For anyone who was watching or listening to PM Theresa May’s address regarding Brexit on the 17th of January, the below chart will look familiar.

 

GBP Price Action 17 Jan 2017
GBP Price Action 17 Jan 2017

Source:tradingview.com

 

To put this chart in some context, towards the tail end of the prior week, elements of PM Theresa May’s speech was leaked, causing markets to further price in the possibility of a hard Brexit. This sentiment carried over into the open of the Asia session on the preceding Monday (16th), resulting in the pound/dollar cross trading as low as 1.19875 – and raising fears of a retest of the October Algo spike low towards 1.16. However most likely due to lower volume on account of the US Martin Luther King holiday, the pound ranged and failed to move lower. Tuesday saw the onset of inflation figures delivering an increase of 1.6% vs. the expected 1.4% – and in a sign of what some may consider insider dealing, cable rallied massively in advance of the data from 1.20400 in the Asia session to 1.21880 by 9:30 GMT.

Just looking at the chart below, it doesn’t require a genius analyst to see the effect Brexit has had on consumer prices already.

 

2016 UK inflation rate
2016 UK inflation rate

Source:tradingview.com

And then came the main event, PM Theresa May’s speech despite being partially leaked, delivered some surprises. While the market had priced in hard Brexit rhetoric, May delivered a mostly balanced speech, and importantly for Cable, indicating that the conditions under which Britain will leave the EU will be put to vote. The markets had not priced this vital piece of information in, and cable rallied for the better part of the day. The key take away here is that the pound is still massively politically sensitive

So, what to do?

Inflation is rising, on account of the currency, and at its current rate there is a risk of inflation overshooting the BOE’s target rate of 2%. Let’s not forget, that during August, the BOE also implemented a large chunk of QE, to the tune of some £435 billion.

And so Carney’s dilemma is this: Can he risk a rise in interest rates to curb an overshoot in inflation, when the underlying causes for this inflation are not from rapid economic growth, but more from a heavily devalued currency?

There is no doubt that the pound’s current value has made the UK “cheaper” for some investors, but the uncertainty and political sensitivity of the Brexit issue has not made the UK more secure, and long term investment is still a concern – especially in the financial and property sectors. Raising interest rates too soon could stifle the easy credit many smaller companies have been relying on, but leaving it to overshoot could start to cause widespread consumer issues. After all, do we really need another Marmite Gate??

Is Oil on The Boil?

Looking at a chart of crude oil futures, you could be forgiven for thinking 2016 did not end with OPEC agreeing to a cut in production.

And although price over the previous week was buoyant above $52.00, since Monday it seemed as though price could easily peak back below the $50.00 level.

 

cle-11-jan-17
Crude Oil Futures Jan 2017

Source:tradingview.com

 

The early decline in the week was a direct result of the continued rig count growth in the US, threatening to create another over supply situation.

As was expected by some, OPECs decision to cut output to 32.5 million barrels a day pushed up the price of oil, but at the same time has now made production a viable option for competitors that were previously priced out when oil was below $50.00

 

crude-barrels-jan-17
Crude Oil Inventories Jan 2017

Source: tradingeconomics.com

 

However despite this, and despite a rise in US crude oils stocks of 4.097 million barrels as the above chart shows. This figure was higher than the expected build of 1.162 million barrels, and should have triggered a another bearish move for the black stuff. However crude oil futures rose from an intra-day low of $50.74 to $52.77.

The reason for this being two fold, firstly There was news that Saudi Arabia will reduce February crude sales to China and southern Asia countries as it slows supply in accord with the November output cut.

Secondly, although the stock rise of 4.097 million barrels at first appeared bearish, there has been an increase in the amount of crude oil being used by refineries across the US. Bloomberg reports some 17.1 millions barrels being used each day last week –  all ahead of planned seasonal maintenance.

This is all good news for oil bulls, as where it seemed prices may struggle above $50.00, they now seem well supported by a number of fundamental factors, for the time being at least. It will be important to maintain a view on supply levels in particular from the non OPEC countries in the coming weeks as producers get used to the higher cost of oil.

 

Is 2017 The start of the Inflation Game?

It is only the start of 2017 and already analysts are questioning what the impact of higher inflation will be.

With preliminary year on year inflation figures for Germany jumping from 0.8% in November to 1.7% in December and Eurozone inflation rising from 0.6% to 1.1% the ECB are now in a difficult situation. The current rise in inflation has been linked to the rise in energy, with Crude Oil futures trading above $53.00 a barrel at the time of writing. And with the OPEC production cut only just starting to kick in, we can anticipate some further bullish momentum when it comes to the black stuff.

With ECB President Mario Draghi having only recently said that tapering the current bond purchasing program was not discussed at the last ECB meeting, it is anticipated that this view point may need to change if inflationary trends continue. After all, the Eurozone economy is starting to see the uptick in prices that the central bankers have been trying to engineer all this time.

 

eu-inflation
2016 EU Inflation

Source: tradingeconomics.com

 

Of course, this is still some way from the ECBs target inflation rate of close to 2%, but if 2017 continues where 2016 left off, then this won’t be too far away. It will take some time to reel in the large amounts of spending, but traders will now be expecting the rhetoric from the ECB to begin to change.

If we keep in mind that currently the Euro is trading at €1.04 against the dollar, there is risk of a fall towards parity should there be any signs of weakness in the Eurozone recovery. Whereas the ECB’s case for a weakened Euro to stimulate inflation and boost exports is valid, any benefits this may bring could be quickly undone if the Euro begins to fall uncontrollably. It will be interesting to see how exactly Mario Draghi and the ECB tackle this, with their next scheduled monetary policy meeting on the 19th of Jan.

So is this all because of that US Election thingy??

By the looks of it, no. It’s quite possible that the amount of event risk in 2016 took everyone’s eyes off the data points for a while, but inflation has been creeping up across the globe …even in Japan!

The culprit, in no small part, has been the price of oil – which has been on fire since February 2016’s lows of $26.00 a barrel, to where they are now, comfortably over $50.00.

The below chart gives a good insight into this. Through the latter half of 2016 we can see the price of oil and the yield of the US 10 Treasury Note increase in tandem. The sudden surge in yield in November of course coming off the back of the US election result, but we can see that the two have experienced a certain level of correlation.

 

10-yr-yield-and-crude-oil-jan-2017
10 year yield vs. crude oil futures

Source: tradingeconomics.com

 

So what does this mean going forward?

If we continue to see the rise in oil, and the associated impact on consumer prices, then we are likely to see the continuation of yield rises. Some would argue this is long overdue given the distorted pricing of bonds as a result of various bouts of QE. Either way it seems the bears are gathering outside the doors of the bond bulls.

Looking Back On 2016

Welcome to The Bond Trader!

The final hours of 2016 are upon us – and given the event risk that has come and gone this year, I am sure there are still a number of people out there still expecting the wheels to fall off the seemingly unstoppable “Post Trump Hard Brexit” bus only for all to be revealed as nothing more than the worlds biggest fake news story… Well, anything is possible – and at the time of writing, there are still a few hours left in the year 2016. So let’s take a few minutes to recap how we got here.

For the last few years central bankers around the world have been desperate for inflation. And despite all the tricks, potions and spells tried there has been little if any significant uptick. The hangovers from 2008 had left many fearful of long periods of deflation and low interest rates.

However 2016 has signalled that maybe a change is in the air. Over a period of five years, and mostly due to drops in the price of Crude Oil (and steel), the Reuters CRB index has declined 58% from the highs of 370 in 2011 before finding a base of 155 earlier this year.

And so it is argued that this period of oversupply in the commodity sector is finally coming to a head. Falling prices are now themselves falling out of the inflation numbers. This transition started to manifest itself at the turn of the year, just before commodity prices formed a base in the first part of 2016.
Rising debt levels and a bond market rally fuelled by central banks determined to keep interest rates low are “so 2015”. The election of Donald Trump as the next US President in November could turn out to be the trigger to the gun aimed at the bond bull. And I must say, this doesn’t feel like a false dawn. This time when we say goodbye to low interest rates, it could be for a very long time.

And so somewhat similar to Dr Frankenstein looking over his monster, and screaming “It lives!”, we cheer the fledgling spurts of inflation. In China, producer prices moved sharply into positive territory for the first time in over 5 years, while inflation in the US, EU and the UK has been trending higher through 2016 – in the case of the UK, predominantly due to the drop in cable following that little Brexit matter.

The prospect of higher inflation quickly manifested itself in the bond market. Simply put, yields rose, and prices fell. Following Brexit and a pre-emptive rate cut, yields on UK Gilts continued to rise from 0.5%, eventually reaching a 6 month high of 1.5%. The decline of the pound against its currency peers can only spell inflation, raising the question of whether or not Mark Carney and the BOE were too quick to cut rates post Brexit? State side, and although still only President Elect, the Trump effect on US Treasuries belies the fact we still don’t know what his plans are. However the expectation of a fiscally stimulating, tax cutting, factory building and trade-organisation-leaving presidency seemed to be enough to cause some major moves in the bond market at the tail end of 2016.

Yields on the US 10 Year treasury Note have risen from lows of 1.36% after the Brexit Referendum, to reach a high for the year of 2.59% in December, with the biggest move coming after the election of Donald Trump.

So where will yields go in 2017? If the below chart is anything to go by – the only way is up. This view works in line with the fundamental assumption that President Elect Trump follows through on his pledges of fiscal stimulus and his somewhat isolationist approach. Let’s not also forget the potential for tapering of the ECBs bond purchasing program, and suddenly 2017 seems very bearish for bond prices. In these circumstances, it’s unreasonable to expect yields to start tapping on the ceiling of 3% soon into 2017.

10yr-yield-2016
10 Year US yield 2016

Chart Source: tradingview.com

TNoteT.