Here are the main questions facing investors and markets as a new trading week beckons.
What will the Federal Reserve say?
Sometimes words matter more than action. A quarter percentage point tightening is all but baked in after the February jobs report, when 235,000 jobs were created — eclipsing market expectations. Of greater importance is whether Fed officials indicate a willingness for a faster rate of tightening in the coming months. Attention will focus on revisions to the central bank’s dot plot, which currently shows three tightenings expected for 2017.
While some in the market think the Fed will not alter its so-called forward guidance for now, such faith in a benign outcome may prove misplaced.
Analysts at Crédit Agricole note: ‘’We believe that, if there is scope for a surprise next Wednesday, it is likely to be a hawkish surprise.’’
A shift towards four rate tightenings and a higher terminal level for Fed funds, along with any hint of the central bank looking at trimming its $4.5tn balance sheet, would all up the hawkish ante for investors. Goldman Sachs on Friday pulled forward its forecast of when the US central bank will begin to normalise its balance sheet to the fourth quarter of 2017, instead of mid-2018 as it had previously thought.
Bank of America Merrill Lynch also highlights how higher odds of a more active central bank have yet to fully stem the bullish outlook for risk assets, let alone shake volatility measures from their current slumber. This, says the bank, is illustrated by the growing divergence between interest rate expectations and financial conditions.
‘’Ultimately, financial conditions that fail to tighten in response to a hawkish Fed could raise concerns of a more hawkish policy stance — in the form of higher dots and/or active balance sheet talk,” says the bank.
Has the ECB set up the euro for a rally?
Yes, but not in the short term. European political risk has been holding the euro back, and investors will largely steer clear of the single currency until at least after the French presidential election. If Marine Le Pen does lose, attention will shift firmly to eurozone growth and inflation, both revised upwards last week by European Central Bank president Mario Draghi.
But that’s for another day. Investors did give the euro a bit of a boost after the ECB meeting, noting its readiness to drop a “sense of urgency” about further monetary easing and the end of soft bank loans.
These, though, are mere “baby steps”, says Standard Bank forex analyst Steve Barrow. The euro could still rally if the ECB carries on in this vein, he adds, but beware of a repeat of the 2013 “taper tantrum”. “These baby steps really will be tiny,” he cautions.
Besides, next week the Fed is a racing certainty to be raising rates. The euro will remain soft so long as market fixation with a strong dollar persists.
Is Opec’s production deal failing?
After being confined to the tightest trading range in a decade, the oil market’s dam wall has broken. US WTI traded below $49 a barrel last week, a level not seen since December, and the Opec production agreement faces a big test. As oil prices retreat, the risk grows that some Opec members will pump more crude to boost revenues, exacerbating the supply glut. Prices had held well above $50 a barrel since the end of November because of strong compliance with output cuts from Opec members.
Now, as US shale production grows and crude inventories build, the pressure is mounting on hedge funds that bet on prices staying elevated. Hedge funds had amassed the largest ever bet on rising prices in the early months of 2017. The extent of the drop may force some to liquidate their positions, potentially leaving the market vulnerable to a correction and putting further pressure on prices.
Opec and other countries outside of the cartel will decide in May whether to extend the supply-cut deal, which was initially agreed for the first six months of 2017.
How much pressure is eurozone QE exerting on liquidity?
European Central Bank president Mario Draghi has offered investors three possible reasons why short-dated German bond yields fell to a record low recently: demand for high-quality assets amid political turmoil; a clamour from investors who can’t use the ECB’s deposit facility; and the central bank’s intervention in bond markets. The final possible cause is, he says, the least likely.
Credit analysts at European banks are not so sure. Data show that the German Bundesbank has been buying shorter dated bonds in recent months, cutting the average maturity purchased from over nine years to just over four years. At the same time, it has made only a small number of Bunds available for use in the short term funding market that underpins the eurozone’s financial system. Together, these factors may be fuelling the plunge in Bund yields.
Strategists at BNP Paribas say the yield moves are a sign of artificial shortages. “The longer the combination of QE and negative rates persists, the more likely are the adverse side-effects to outweigh the benefits of QE at the margin.” If last year’s collateral squeeze is repeated, the ECB is going to come under pressure to do more to help.
When will the Bank of England stop buying corporate bonds?
The Bank of England began buying corporate bonds in September as part of the central bank’s plans to cushion the economy from any Brexit fallout.
It planned to buy £10bn over an 18-month period, but has already bought £8bn just six months into the programme, which could now end as early as next month.
The purchases have supported prices of bonds and encouraged issuance in a market that has faded into the background compared with its European and US counterparts during recent years.
However, the rapid pace of buying also has raised questions over what will happen when the £10bn target is reached. Analysts have suggested the conclusion of the Bank of England programme could reduce liquidity in sterling bond markets by removing an important “valve” for selling pressure.
The next clue will come on Thursday, when the Bank releases its data on purchases.
