FED Meeting on the Horizon

March 12, 2016

“So mortgage bonds are dog shit. CDO’s are dog shit wrapped in cat shit”
Mark Baum (Steve Carell), The Big Short 2015

Mr. Mario Draghi has left the stage, leaving us wondering whether the new measures introduced represent the last desperate attempt to save the Euro zone from the deflation monster or it is the final, lethal strike delivered with full confidence to resolve the situation once and for all. Whatever the case will be in the end, the show itself was actually rather boring, maybe because the expectations were extremely high again or maybe because the ECB perhaps over played its hand by going “all in”, leaving itself fully exposed to numerous elements, such as the oil price. The whole press conference was like a massively promoted heavy weight boxing match that ended in the first round, 10 seconds after the bell.

Euro clearly wasn’t “crushed” by the bad news as after a relatively small sell off, we all had the pleasure to witness the famous December reaction again. The distance from the lows, made during the press conference, to the highs made after Mr. Draghi had ended his speech, is almost 400 pips which lines up quite well with what we saw in the end of the 2015. What makes the whole drama even more intriguing is the fact that this is not an isolated incident, where the market completely ignores the central bank’s decisions and basically gives them the middle finger. Of course, we have to keep in mind that the package, the ECB introduced yesterday, was well beyond expectations and it will take some time, before we’ll see the real market reaction.

Regardless of the unplanned surge in Euro during/after the press conference, Mr. Draghi once again proved that he is willing to take drastic measures to ensure that at least the ECB is doing everything it can to improve the overall recovery in the Euro area. However, as mentioned last week, it seems that the European Central Bank is basically alone in this fight as the implementation of structural reforms is still lagging and politicians are not willing to make risky but necessary decisions to modernize the whole concept of the European Union/Euro area. Some policy makers in the Euro area have already shared their doubts that the measures taken are not going to fix anything as long as governments won’t increase their efforts to actually make changes.

All in all, only time can tell how successful ECB’s decisions are going to be in the long-run and even if their efforts fail, no one can say that they didn’t try or that they didn’t do enough – they’ve done more than anyone expected.

Now that the ECB has shown its cards, it’s time to turn our focus on the Federal Reserve. Next week, on Wednesday, we have the pleasure to find out what Ms. Yellen thinks about current state of the US economy, stock market and developments surrounding the emerging markets. In general, market participants don’t expect any changes from the FED when it comes to the interest rates but we are all anxious to find out if the “4 rate hikes in 2016” plan is still on the table – in other words – forward guidance is the key element this time.

Since December, when the FED hiked the rates by 25 bps, we’ve had mixed data from the United States and a fair amount of analysts are extremely skeptical about any further tightening from the FED. US manufacturing sector is still not doing overly well according to the recent PMI’s and on top of that, it seems that the growth pace of the service sector is also starting to slow down. As the chart below shows, manufacturing PMI started falling first and soon after, the services PMI followed – the question is where and when these two lines will meet again?

ism manu vs non manu

When the manufacturing PMI started falling in the beginning of the 2015, the consensus was that it is not important because the United States is a service based economy. As time passed, the story changed and now some claim that the slowdown in the manufacturing sector has spilled over to the services sector and we may see further weakness in both, before any meaningful recovery. I don’t want make any predictions regarding either of them but when it comes to the manufacturing, I’m not overly optimistic as Philly FED Manufacturing Index, Empire State Manufacturing Index and Richmond Manufacturing Index are all in the negative territory at the moment.

In light of that, it's difficult to say what FEd is going to do next Wednesday but on the other hand, I seriously doubt that they’ll change their forward guidance especially now, when the ECB has expanded its asset purchase program, meaning that the possibility of another rate hike in 2016, will remain on the table.

Capital Properties FX