Central banks in a “wait-and-see” mode, amid improving economic data
The Fed remained on hold, as expected, failing to clarify the prospect of a rate increase in March. It was more optimistic on the economic outlook, with markets expecting the next hike in June (c. 70% probability).
The US labor market report provided support for the Fed’s inaction. Specifically, job creation was strong, with nonfarm payrolls up 227k (exceeding consensus expectations). However, improving conditions are attracting more people to the labor force (up 0.2 pps to 62.9%), increasing labor market slack and thus reducing the prospect of an intensification of wage pressures.
The Bank of England maintained its policy rate at 0.25% and its two-sided bias in view of a growing consensus that a tightening bias could have been adopted due to stronger-than-expected economic data, but also that the economy still had sizeable slack.
The Bank of Japan (BoJ) also remained on hold on Tuesday. The BoJ will continue to defend its yield-curve targeting framework (of 10-Yr JGB yield “around zero”). Indeed, on Friday, when the 10-Yr JGB reached 0.15% intra-session, the BoJ intervened aggressively, buying 10-Yr JGBs at 0.11%.
Euro area growth was in line with momentum contained in the recent PMIs, with real GDP accelerating to 2.0% qoq saar in Q4:2016 from an upwardly revised 1.8% Q3. The unemployment rate has decreased by 2.5 pts to 9.6% (the lowest rate since May 2009) and headline inflation is expected to accelerate towards 2% (from 1.8%) by mid-2017. We expect the ECB to announce a “formal” tapering of its QE purchases, in mid-2017 (starting from January 2018), unless political risks increase.
Global equity markets were flat on a weekly basis, as statements and actions from the US administration increased the risk of potential trade tensions and counteracted the positive Q4 earnings season. Note that S&P500 EPS to date for Q4:2016 (with 55% of firms having reported) are up by 5.6% yoy compared with expectations of 3% at the start of the reporting season.
The S&P 500 was broadly stable on a weekly basis, albeit posting strong gains on Friday, with the financial sector overperforming (+2%) on the back of a strong labor market report and President Trump’s intention to dismantle the Dodd-Frank 2010 Act (that imposes heavy regulation on the sector). The Nikkei 225 underperformed (-2.8% wow), linked to the stronger JPY.
The USD lost further ground in a week underpinned by comments from US officials that major peers (EUR and JPY) are “artificially” undervalued. The “jawboning” by the new administration will increase volatility in the short term, albeit fundamentals (expansionary fiscal and tighter monetary policy) remain supportive for a stronger USD (compared with current levels).
Government bond yields declined, with the UST 10-Year down slightly (by 2 bps wow to 2.47%) and 10-Year Bunds declining 5 bps wow to 0.41% (with the OAT/Bund spread increasing sharply due to uncertainty regarding the French elections – see graph on page 3). Gilts overperformed, with 10-Year yields down by 12 bps wow to 1.35%, mostly due to a dovish BoE.