Markets Roundup. Yellen mildly hawkish at this week s FOMC? 14 March 2016 Research

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1 Markets Roundup Research CONTENTS Market Movers 2 Economics Weekly Calendar 5 Yellen mildly hawkish at this week s FOMC? After the ECB surprised the markets last Thursday, financial market participants will be curious what Janet Yellen will have to say in the press conference at the FOMC meeting on Wednesday. However, first there is the Bank of Japan tomorrow (p.2-p.4). Central Bank Policies 6 Forecast Table 7 Interest Rates (3M 1yr) 8 Gov t Bond Yields (2yr 1yr) 9 Interest Rate & Bond Futures 1 Equities, Currencies & Commodities 11 DATA RELEASES United States 15/3 Retail sales 16/3 Housing starts 16/3 CPI 16/3 FOMC meeting The Chart of the Week shows the 2-year and 1-year bund yield and the price of oil, which is an update of the same Chart of the Week of two weeks ago. Last week s ECB meeting resulted in a strong appreciation of the euro exchange rate from and intraday low of 82 to and a lot of volatility in the stock market. Although it got less attention than the swings in stocks and the exchange rate, what was quite remarkable was that the short end of the yield curve increased during ECB president Draghi s press conference last Friday as he indicated that he won t be cutting rates anymore after last Thursday s rate decrease. Additionally, the longer end of the curve after an initial dip surged as well: the 1-year yield jumped last Thursday to.33%. Therefore, the question is if the bond markets are heading into the same scenario as last year when after dipping to 6% in April the 1-year bund yield rose within a short period of time to higher than %. This occurred shortly after oil prices started to trend upwards. What we have seen this year is that the 1-year bund yield dipped to.1% on 29 February and that the trend seems to be turning upward again and this is happening just as last year shortly after oil prices are staging a come-back and inflation expectations are pushed up again. Eurozone 14/3 Industrial prod. 17/3 CPI United Kingdom 16/3 Labour market report 17/3 BoE meeting RESEARCH Erwin Langewis E: nibc.research@nibc.com Chart of the Week: bund yield and oil prices Percentage USD per barrel Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 2-year German yield 1-year German yield Oil price, WTI (RS) Important disclosures appear on the final page of this document

2 MARKET MOVERS: REVIEW & PREVIEW Financial markets are in the grips of the central bank meetings from the ECB, the BoJ, the BoE and the Fed. The Fed will have its policy meeting on Wednesday, but the big news was the ECB s frontal assault on deflation risks last Thursday by the announcement of rate cuts (the refi rate was surprisingly cut from 5% to % and the deposit rate was lowered from -.3% to -.4%), an expansion of its QE programme from 6bn euro to 8bn euro per month and the introduction of a new series of TLTRO s. Moreover, the ECB expanded the number of asset classes that can be purchased under its QE programme into investment grade euro-denominated bonds issued by non-bank corporations. Clearly, this was much more than market participants had on average expected from the ECB. Market response to central bank seems puzzling The market reaction to the ECB policy announcements, however, was interesting to say the least. The initial response to the ECB s announcements on Thursday was in line with what one would expect the markets to do when the central bank announces more policy easing than was priced in: the euro fell sharply against the US dollar from 97 to 83, the yield curve steepened somewhat and stocks and commodities surged. However, apparently there were too many euro-shorts just after the ECB s policy changes were announced via its press statement and as the euro failed to fall further below the support levels of around 82 during the initial comments made by Mario Draghi in his press conference the euro started to rise again. It, however, turned into a rout of euro shorts after Draghi explained that he doesn t anticipate more rate cuts based on current view. This remark set in motion a turbo-charged reversal in the euro exchange rate which rallied in less than 4 hours from 83 to against the US dollar, while European stock markets collapsed by 5% from their highest point of the day. Moreover, a sharp sell-off in bunds was triggered. The 2-year yield jumped from -.56% to -.45% and the 1- year yield climbed to.33% after falling to.16% just when Draghi started talking. This spectacular volatility may not have been the intention of the ECB president. However, it was the consequence of him clearly pointing at policy rates at being at the low for this cycle. Accordingly, we do not expect further rate cuts anymore. What are counterintuitive currency moves signaling? Last Friday things appeared to be under control again as stock and commodities markets resumed their relentless advance and the bund yield was pushed below.3% again. Nevertheless, it is quite intriguing that the last three easing moves by the major central banks resulted in a sharp appreciation of their currency (see charts below). It occurred first at the ECB meeting of 3 December where the ECB deposit rate cut from -.2% to -.3% actually fell short of expectations and resulted in a surge in the euro. This was followed by the unexpected rate cut by the Bank of Japan into negative territory on 29 January. This resulted in surge in the yen instead of depreciation. And yet again, the ECB sees its policy easing being followed by an appreciation of the euro exchange rate. The ECB meeting of 3 December set off a depressing Christmas and New Year period for stock, commodity and high yield markets. The mentioned Bank of Japan meeting only worsened the market volatility. Thus, the question is if last Thursday s market response to the ECB s policy changes also signals market mayhem ahead? Euro and yen driven by central banks EUR/USD USD/JPY (inverted axis) Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 EUR/USD USD/JPY (RS inverted axis) Stock index in Europe (Euro Stoxx 6) index Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Euro STOXX 6? Markets Roundup 2

3 Meanwhile, the new (quarterly) ECB staff forecasts for growth and inflation were also published at the ECB meeting. These were generally adjusted downward. Eurozone GDP growth is expected by the ECB at 1.4% this year and at 1.7% in 217. Inflation is expected by the ECB at.1% in 216, whereas this forecast still was % in the previous forecast (in December). The ECB anticipates that inflation will gradually increase in 217 and 218. However, the ECB said that 6 months ago as well. Although the ECB s action of last Thursday will probably be advertised by the ECB as a new ingenious plan to combat deflation; in reality the ECB has obviously little control over short-term fluctuations in the inflation rate in the Eurozone. The recent drop in the inflation to rates slightly below zero can be explained by sharp falls in oil prices and not by the idea that the ECB has not been doing enough to make monetary conditions easy. As policy rates were at zero percent or lower and a QE programme worth 6bn euro per month was in place until this month it appears that monetary policy had been more than easy enough. Yellen mildly hawkish at FOMC on Wednesday? The Fed will likely remain on hold on Wednesday, but should strike a mildly hawkish tone given the recent pick-up in core inflation, the surprisingly strong job growth and continuous growth in consumer spending. During tightening cycles the Fed normally does what the markets expects her to do. This also happened during the rate hiking cycle of 24-26; the symbioses between Fed and the markets back then meant that the markets discounted every rate hike the Fed implemented beforehand. The reason for the Fed to be hawkish % change on a year ago US Core CPI US core PCE deflator Hourly wage increases Eurozone inflation low in 216 % change on a year ago Eurozone CPI Eurozone Core CPI Car sales still strong, but past its peak? In millions annualised Car sales (light vehicles) Obviously as the ECB has been forecasting inflation too high for some time now, it can just as easily be the case that the ECB will underestimate the impact its policy will have on medium to longer term inflation. Especially if a combination of depreciating euro exchange rate and recovering commodity and energy prices would occur in the near future, it could increase inflation in the Eurozone markedly. Whether or not the recent rebound in energy prices is for real remains to be seen, but a weaker euro is eventually in the cards as the ECB s policy is too strongly diverging with the Fed. Nevertheless, such a second leg down in the euro (after a first one in late 214/early 215) remains difficult to time. Momentarily, a rate hike is priced in for June and as such it seems likely that the Fed will not say anything that will affect this expectation negatively given the intention of the Yellen & Co. to raise rates to higher levels. It will also be interesting to see if the Fed adjusts its inflation forecasts higher given recently stronger than expected CPI and PCE deflator figures. Apart from the Fed meeting the CPI figures for February will be published on Wednesday. If these numbers are again higher than the market expectation (see Economic Calendar on page 5) it will increase pressure on the Fed to become more hawkish. Also interesting this week are the February Markets Roundup 3

4 retail sales figures, which are due for tomorrow. Car sales have not strengthened any further last few months and as such retail sales growth has slowed. The consensus is a small decline in retail sales. All in all, as the ECB had all the attention last week, the focus of the markets will likely shift to the US. However, also the Bank of Japan will have its policy meeting tomorrow and the Bank of England on Thursday. There are, however, no policy changes expected from these two central banks. Markets Roundup 4

5 ECONOMIC CALENDAR 14 MARCH 18 MARCH, 216 UNITED STATES Date Time Indicator BN Survey Prior Tuesday 15 March 13:3 Retail Sales Advance MoM Feb -.1%.2% 13:3 Retail Sales Ex Auto MoM Feb -.2%.1% 13:3 PPI Final Demand YoY Feb.1% -.2% 13:3 PPI Ex Food and Energy YoY Feb 1.1%.6% 13:3 Empire Manufacturing Mar : NAHB Housing Market Index Mar : Business Inventories Jan %.1% Wednesday 16 March 13:3 Housing Starts Feb 1139k 199k 13:3 Building Permits Feb 121k 122k 13:3 CPI MoM Feb -.2% % 13:3 CPI Ex Food and Energy MoM Feb.2%.3% 13:3 CPI YoY Feb % 1.4% 13:3 CPI Ex Food and Energy YoY Feb 2.2% 2.2% 14:15 Industrial Production MoM Feb -.2%.9% 14:15 Capacity Utilization Feb 76.9% 77.1% 14:15 Manufacturing (SIC) Production Feb.1%.5% 19: FOMC Rate Decision (Lower Bound) Mar-16.25%.25% 19: FOMC Rate Decision (Upper Bound) Mar-16.5%.5% Thursday 17 March 13:3 Current Account Balance 4Q -$114.b -$124.1b 13:3 Philadelphia Fed Business Outlook Mar :3 Initial Jobless Claims Mar k Friday 18 March 15: U. of Mich. Sentiment Mar P EUROZONE Date Time Indicator BN Survey Prior Monday 14 March 11: EC Industrial Production SA MoM Jan 1.4% -% 11: EC Industrial Production WDA YoY Jan 1.2% -1.3% Thursday 17 March 11: EC Trade Balance SA Jan -- 2b 11: EC Construction Output MoM Jan % 11: EC Construction Output YoY Jan % 11: EC CPI MoM Feb.1% -1.4% 11: EC CPI YoY Feb F -.2% -.2% 11: EC CPI Core YoY Feb F.7%.7% UNITED KINGDOM Date Time Indicator BN Survey Prior Wednesday 16 March 1:3 Claimant Count Rate Feb 2.2% 2.2% 1:3 Jobless Claims Change Feb -8.5k -14.8k 1:3 Average Weekly Earnings 3M/YoY Jan 2.1% 1.9% 1:3 ILO Unemployment Rate 3Mths Jan 5.1% 5.1% 1:3 Employment Change 3M/3M Jan 15k 25k Thursday 17 March 13: Bank of England Bank Rate Mar-17.5%.5% 13: BOE Asset Purchase Target Mar 375b 375b Source: Bloomberg News Markets Roundup 5

6 CENTRAL BANK POLICIES United States FOMC Policy interest rate: Federal funds target rate Last action: +25bps on 16 December 215 Next Meetings: 16 March Policy Outlook: The Fed funds rate has been cut to an unprecedented target range of -.25% during the financial crisis of 27/8. Furthermore, the Fed started to purchase assets and after Operation Twist ended in 212, decided to increase the size of asset purchases per month by a further USD 4bn. The QE3 programme has ended. A first rate hike was finally implemented in December 215. Recent market turmoil will likely keep Fed on hold early 216, but it is expected to get back into play in the course of 216. FOMC minutes: Eurozone ECB Policy interest rate: Main refinancing rate, deposit rate. Last action: -1 bps in deposit rate on 3 December 215 Next Meetings: 21 April Policy Outlook: The ECB lowered its key policy rates by 5bps and its deposit rate by 1 bps on 1 March. The refi rate is at % and the deposit rate at -.4%. In addition to liquidity injections (TLTROs), the ECB will be purchasing bond securities at a pace of EUR 8bn per month as of April. United Kingdom - Bank of England Policy interest rate: Repo rate Last action: -5 bps on 5 March 29 Next Meetings: 17 March Policy Outlook: Inflation rates are falling due to lower energy prices. We expect the BoE to keep rates unchanged at.5% at least till mid-216. Perhaps that a rate hike will be implemented in H BOE minutes: Markets Roundup 6

7 FORECAST TABLE United States Yearly averages Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 GDP (quarter-on-quarter) (year-on-year) Consumer Price Index (year-on-year) Federal funds rate * yr Treasury yield * Eurozone GDP (quarter-on-quarter) (year-on-year) Consumer Price Inflation (year-on-year) ECB refi rate * Germany GDP (quarter-on-quarter) (year-on-year) Consumer Price Inflation (year-on-year) yr bond yield * Netherlands GDP (quarter-on-quarter) (year-on-year) Consumer Price Inflation (year-on-year) United Kingdom GDP (quarter-on-quarter) (year-on-year) Consumer Price Inflation (year-on-year) BoE bank rate * yr bond yield * *end of period Markets Roundup 7

8 INTEREST RATES (3M 1YR): ACTUALS & CURVE Policy Interest Rates (%) 3m Interest Rates minus Policy Rate (bps) m Interest Rates (%) 12m minus 3m Interest Rates (%) USD Libor Euribor GBP Libor 12m Interest Rates (%) 1 yr Interest Rate Swap Spread (bps) USD Libor Euribor GBP Libor Eurozone United Kingdom Source: Bloomberg Update: 3/14/161:29 Markets Roundup 8

9 GOVERNMENT BOND YIELDS (2YR 1YR): ACTUALS & CURVE 2 yr Benchmark govt Bond Yields (%) 1 yr minus 2 yr govt Bond Yields (%) yr Benchmark govt Bond Yields (%) 1 yr Interest Rate Swap Spread (bps) Real govt indexed Bond Yields (%) Estimate of Inflation Expectations (%)* US TIPS 217 (indexed to CPI) FR OATei 217 (indexed to Euro CPI) UK IL Gilts 217 (indexed to RPI) United States (CPI) Eurozone (CPI) United Kingdom (RPI) * Difference between nominal government bond yield and inflation-indexed bond yield ("breakeven inflation") with the same maturity (217) Source: Bloomberg Update: 3/14/161:29 Markets Roundup 9

10 INTEREST RATE & BOND FUTURES: MARKET EXPECTATIONS United States: 3m Eurodollar* United States: 1yr treasury yield* Current JUN 16 SEP 16 DEC 16 MAR 17 JUN Current JUN 16 SEP 16 DEC 16 Euro zone: 3m Euribor Euro zone: 1yr govt Bond Yield Current JUN 16 SEP 16 DEC 16 MAR 17 JUN 17 Current JUN 16 SEP 16 DEC 16 United Kingdom: 3m Sterling United Kingdom: 1yr GILT Yield Current JUN 16 SEP 16 DEC 16 MAR 17 Current JUN 16 SEP 16 Current ** Two weeks ago One month ago * Forward interest rates and bond yields implied by futures contracts. Source: Bloomberg Update: 3/14/16 1:29 Markets Roundup 1

11 EQUITIES, CURRENCIES AND COMMODITIES Major Equity Markets Major Currencies S&P 5 (LS) FTSE Eurotop3 (LS) FTSE1 (RS) EUR/USD (LS) EUR/GBP (RS) USD/GBP (RS) Commodity Prices Oil Price* /7/212 31/7/ DJAIG Index Spot price (USD) Spot price (EUR) Source: Bloomberg; Update: 3/14/161:29 * West Texas Intermediate (WTI) Cushing Crude Oil Spot Price Disclaimer Certain statements in this presentation prepared by NIBC Bank N.V. ( NIBC ) are not historical facts but forward-looking statements. Words such as believe, anticipate, estimate, expect, intend, predict, project, could, may, will, plan and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. These statements are largely based on NIBC s current view with respect to future events and financial trends that we believe may affect the economy, the credit market in general and interest rates. By their very nature, forward-looking statements involve uncertainties and are subject to certain risks, including, but not limited to, the risks and uncertainties as addressed in this presentation, and/or changes in general economic conditions, changes in credit spreads or interest rates. The forward-looking statements speak only as of the date of this presentation. NIBC does not undertake any obligation to update or revise forwardlooking statements contained in this presentation, whether as a result of new information, future events or otherwise. The information and opinions presented here have been obtained or derived from public sources believed by NIBC to be reliable at the date of publication of this presentation. No warranty, prediction or representation is made as to their accuracy or completeness and they are subject to change without notice. NIBC does not make any representation, warranty or prediction that the results anticipated by such forward-looking statements will be achieved, and such forward-looking statements represent, in each case, only one of many possible scenarios and should not be viewed as the most likely or standard scenario. NIBC accepts no liability for (direct, indirect or consequential) loss arising from the use of the information and figures presented. This material is not to be relied upon in substitution for the exercise of independent judgment. When preparing this presentation NIBC has not taken into account any customer s, creditor s or investor s objectives, financial resources or other relevant circumstances and the opinions and recommendations herein are not intended to represent recommendations for particular creditors, customers or investors. NIBC is the owner of all works of authorship including, but not limited to, all design, text, sound recordings, images and trademarks in this presentation unless otherwise explicitly stated. The use of NIBC s material, works or trademarks is forbidden without written consent, except were otherwise expressly stated. Furthermore, it is prohibited to forward or publish material made or gathered by NIBC without its prior written consent. Markets Roundup 11