KUWAIT: With its December first tightening in 9 years, the Fed so-called “lift-off” is finally behind us. The federal funds rate is up 25 bps to a target of 25-50 bps. In the beginning of 2016 markets can now move on to the next set of questions. How much and how fast for the Fed? What of the impact on the US economy, the global economy, commodities, currencies etc…
Analysts and markets are for the most part expecting a 2016 slightly above the 2014 and 2015 growth. Indeed, the IMF is looking for world GDP growth of 3.6 percent, despite the worries emerging from China. For the large economies, the US is expected to grow 2.8 percent, the Euro area 1.6 percent, Japan 1.0 percent, China 6.3 percent and emerging markets at 4.5 percent.
Under this scenario, markets expect the Fed to raise policy interest rates 75-100 bps into December 2016, while the Fed is “signaling” closer to 150 bps. On the other side of the Atlantic, during its last meeting, the ECB disappointed markets by “only” cutting its deposit rates and extending its current QE program, from September 2016 to March 2017. It also failed to meet market expectations of an increase in its monthly purchases of securities currently at euros 60 billion. That ECB announcement, in December, prompted a large and swift correction in the euro rate by almost five percent.
Market participants in the beginning of 2016 will be reassessing the call that had the policy divergence, between the ECB and the Fed, caused the recent one-way dollar rally. This reassessment will be affected by lower oil prices that will continue to weigh on inflation. In light of the less dramatic central bank “divergence”, analysts have revised their views on the dollar expecting the appreciation to become less pronounced than in 2014 and 15.
Another market disappointment came from the December OPEC meeting. Indeed, oil prices in December continue to slide as OPEC kept its guidance quota unchanged at 30 million barrel per day, with Iran still poised to hike production ahead. Dashed hopes of a production cut send oil prices tumbling toward 9-year lows. Equities in the advanced economies have seen pressure from oil equities but also from deflation fears and concerns that lower oil prices may be signaling weaker growth again especially with China million Dollar question of soft or hard landing.
The new lows in commodities point not only to a weak industrial demand, imbalances between supply and demand, but also the continued strength of the USD.
Strong US economy in 2016
US employment gained 211K in November, with unemployment steady at 5.0 percent and wages advancing close to 2.0 percent on a yearly basis. Retail sales, car sales, and home sales are also good enough to support the Fed’s view of US growth topping 2.0 percent in 2016, and that the time has finally come to raise short-term rates above the zero bound set back in 2009.
The negative effect of the less accommodative monetary policy on bond yields should be limited in the beginning of 2016. In contrast to the Fed, the ECB and BOJ are set to continue expanding their balance sheets significantly over the coming year. While global economic growth for 2016 is expected to improve only slightly, the US, signs of higher wage pressures are appearing. The year or year change of average hourly earnings broke out of a six-year range, rising to its highest level since July 2009. If the breakout is sustained, the probability of higher inflation would potentially increase.
The US housing market in 2016 faces several headwinds. The latest figures in the sector suggest moderate growth ahead. Sales of existing homes fell 3.4 percent in October after a September surge, as rising home prices and tighter inventory challenged potential buyers.
Europe continues to heal
The accommodative monetary policy implemented by the European central bank should continue into 2016. This policy divergence is expected to keep the Euro currency under pressure, and in turns help the economy to close its output gap. The ECB’s economic models suggest that a 5 percent decline in the Euro’s trade-weighted exchange rate might lift GDP by 0.3 percent and inflation by as much as 0.5 percent. As a result, there is a strong correlation between a weaker Euro and a pick-up in the European economic growth.
Eurozone economic data
As their policy has proven to be successful, the ECB is likely to continue to play the same game and not tolerate any euro movement to the upside, whether by intervening verbally or through their policy decisions. Political risks however continue to loom in Europe and could play a major role in 2016. Although the situation in Greece has improved, there is an increase in political risks elsewhere. European countries are seeing a political reshuffling that could potentially create more volatility in markets.
A potential concern for investors in 2016 is the upcoming UK EU referendum. The polls are close, and this could keep volatility elevated. The Bank of England is expected to hike its interest rates in the first half of 2016, with the economy near full employment, rising real wages and growth running above trend. The problem remains that in the last quarter of 2015, UK economic data disappointed on multiple fronts. Bank of England policymakers also expressed their concerns over falling commodity prices, stating that low oil prices and subdued wage growth are keeping a lid on inflation.
In the beginning of 2016, external and political drivers will be the major catalysts for the Sterling Pound. With inflation prospects looking subdued and with Europe continually stealing growth from its major partners, the benefits from UK positive employment and cheaper commodity prices have run out leaving the BoE worried about deflation and postponing any interest rates hike further into 2016, possibly beginning of 2017.
BoJ change of plans
The Bank of Japan’s quantitative easing program is still expanding by at least 10 percent of GDP per year. With underlying inflationary pressures still muted, the pressure on the central bank to remain accommodative is significant. More policy innovation could be implemented in 2016. Japan continues to have the best earnings revisions of any major region. In addition, Japans’ exposure to China remains relatively high. Export exposure is three times higher than in Europe. Should the economic slowdown in China worsen, the country would continue to be negatively affected.
In December, the Bank of Japan surprised markets by keeping policy unchanged at its current level of ¥80 trillion expansion. The BoJ has started to realize the little extra benefit of increasing purchases from the current level at least in terms of political risks associated. Moreover, a weaker yen from these levels is not likely to significantly improve exports volumes at the expenses of being called a currency manipulator.
Emerging markets remain under pressure in the beginning of 2016 from the same global macro headwinds already in place in 2015. The negative effects of weak oil prices and commodities, of a sharp strengthening in the US dollar, of a tighter Fed monetary policy and of a weakening in Chinese growth momentum will unfortunately continue to drag economic growth prospects in these regions. Moreover, the dollar strength will put into light the large exposure of Emerging markets with debt denominated in dollar.
The third quarter growth of 2015 was reported at 6.9 percent down from 7.0 percent the previous quarter, but many suspect the actual growth rate to be under that pace. In parallel, the Chinese Renminbi was added to the IMF’s SDR basket of currencies with a weight of 10.9 percent, effective October 2016, adding respectability and credibility to the Chinese currency
In December, the PBoC published a new trade weighted exchange rate index for the Renminbi. The statement released said that the intention of this was to ‘shift how the public and the market observe the RMB exchange rate movements. The statement goes on to say that it would be more appropriate to measure the performance of the RMB against both the US dollar and also the basket of trade weighted currencies.
The PBoC expects the new basket of currencies to be a more explicit reference in setting the value of the RMB in the future. Most importantly, they see this as a signal that China does not intend to engage in competitive devaluation.
Given the strength of the US dollar, markets have started to assume that the PBoC is trying to use the basket as a justification to further weaken the Renminbi and prop up the Chinese economy
Kuwaiti dinar at 0.30350
The USDKD opened at 0.30350 yesterday morning.