Wednesday, November 22, 2017

Capital Markets: "Global Equity Rally Resumes, while Dollar Slips"

From Marc to Market:
Global equities are on the march. US indices shrugged off their first back-to-back weekly decline in three months to set new record highs yesterday. The MSCI Asia-Pacific followed suit and recorded their highest close. The Dow Jones Stoxx 600 is struggling, as the CAC and DAX are nursing small losses.

The synchronized global upturn and prospects for continued abundance of liquidity appear to be underpinning sentiment. At a speech in NY late yesterday, Yellen warned against raising rates too quickly and repeated her sense of mystery over the decline in inflation this year. The US two-year yield softened marginally, and the Fed funds futures rose. At 1.295%, the implied yield of the December Fed funds futures contract is precisely at what we think is fair value assuming a rate hike at the next FOMC meeting.

There seems to be some confusion
over what Yellen means, though she may very well be the most plain-speaking Fed Chair. She is not referring to structural influences. She is referring to the recent decline. Specifically, core CPI fell from 2.3% in January to 1.7%, where it was from May through September before ticking up to 1.8%. The targeted core PCE deflator fell from 1.91% last October to 1.30% in August before rising to 1.33% in September. It is this decline she regards as mysterious but sticks to the working hypothesis that the decline is due to a number of idiosyncratic factors.

Some reports play Yellen's dovish warning but also accused her of being too hawkish when the Fed last hiked rates in June. Others suspect that her caution against raising interest rates too fast is a signal to her successors at the Fed. Still, others are linking her dovish comments to the risk that the minutes from last months' FOMC meeting that will be released this afternoon will show some officials concerned about an undershoot of unemployment. Recently there has been some evidence of greater wage increase for employees in some sectors, including what are regarded as blue-collar occupations.

The main event today, however, is in the UK as Chancellor of the Exchequer Hammond delivers his Autumn Budget to parliament. There is much pressure on Hammond to deliver. Former Prime Minister Cameron thought a referendum on the EU would resolve the conflict that was ripping apart the Tory Party. Rather than resolve it, the referendum nationalized it, and the Tories lost their parliamentary majority. The markets may be particularly sensitive to the new forecasts by the OBR. The poor productivity record means weaker growth prospects, which in turn eat away at latitude to provide much fiscal succor. There continues to be the talk of a cabinet reshuffle....