Markets fret over the pace of US monetary policy tightening (specifically balance sheet reduction)
The minutes of the March 14-15 Fed meeting were positive regarding the US economy, as well as signaling possible upside risks from fiscal policy, thus confirming that policymakers expect growth to remain strong in 2017, despite a weak first quarter.
Note that the US unemployment rate fell by 0.2 pps to 4.5% in March (the lowest since May 2007 and below the Fed’s long-term estimate of 4.7%). Nevertheless, other details of the labor market report were mixed (see Economics section).
Importantly, the minutes noted a discussion on possible changes to the Fed’s reinvestment policy for both its Treasury ($1.7tn) and agency MBS holdings ($1.7tn). Specifically, most FOMC members considered it appropriate beginning later this year to reduce the Fed’s balance sheet strategy. Its implementation would likely occur through a gradual phasing out of reinvestments.
The pace of reduction is the key question. The option of ending reinvestments suddenly could lead to an excessive tightening of financial conditions, and may also lead to market volatility. Thus, we expect the Fed to wind down its reinvestments of its holdings in both USTs and agency MBSs gradually.
Mr. Draghi stated that further evidence on inflation sustainability is warranted, before altering the ECB’s currently accommodative stance. Euro area government bond yields declined on a weekly basis, with the German government 10Yr bond yield down by 10 bps to 0.23% (a six-week low).
US and Chinese officials agreed to a 100-day plan aimed at reducing bilateral trade imbalances (see graph). As a result, concerns for trade-related aggressions between the two countries have eased, for now.
Geopolitical concerns have increased following the US missile strike on Syria, as a response to the gas attacks in Idlib. This development raises tensions between the US and Russia and, as a result, Russian assets recorded losses (MICEX index down by 1.7% and the Ruble weakened against the US dollar by 1.5% to RUB 57.25/$, a 2-week low on Friday).
Global equity markets were broadly flat (MSCI World: -0.2% wow, +5.0% YtD). Investor attention will now shift to the US earnings season for Q1:17, which starts on April 13th. Consensus expects S&P500 EPS to increase by 8.5% yoy in Q1:17 from 5.1% yoy in Q4:16.
Oil prices continued to strengthen, with the WTI up by 3.2% wow to $52.2/barrel. In the past two weeks, oil has recovered markedly (c. 11% for WTI and 9% for Brent), driven by expectations for an extension of the OPEC agreement, unplanned production curbs (i.e. Libya) and geopolitical events.
The Greek government agreed with its lenders on the main outstanding issues of the 2nd review of the economic programme. Once a final agreement is reached, and the accompanying legislation passed through Parliament, discussions on debt relief -- a necessary condition for IMF participation -- will begin. 10Yr GGBs bond yield spread over the German Bund declined by 23 bps on Friday (7/4) to 664 bps, and by 6 bps on Monday to 657bps (see graph page 3).