Hawkish Fedspeak Drove Dollar Strength, Higher UST Yields as December Meeting Draws Closer

5 October 2016

Rates & FX Market Update

Hawkish Fedspeak Drove Dollar Strength, Higher UST Yields as December Meeting Draws Closer

Highlights

¨   Global Markets: Positive US outlook supported an impending FFR hike, driving a stronger USD (+0.5%) and higher UST yields (+3-6bps) overnight. Fed’s Lacker (voter in 2018) argued for the need for pre-emptive hikes to mitigate upside inflation surprises, supporting Fed’s Mester and George hawkish camp. We expect an upper limit of 1 FFR hike in 2017; stay mild overweight USTs. Elsewhere, the EUR erased losses towards the end of the session to close relatively flat overnight, after reports surfaced that ECB is considering a QE taper, though swiftly denied by the bank’s spokesperson. The governing council’s failure to communicate the program’s continuity plans weigh on policy clarity, where we remain inclined towards a mildly bearish EUR stance. In Australia, RBA held rates at 1.50% as expected, with the bank remaining mildly positive towards the employment outlook. While the hurdle towards further easing has been raised slightly under governor Lowe, the RBA is likely to keep conditions accommodative into 2017, limiting any protracted climbs in ACGB yields; stay mild overweight ACGBs.

¨   AxJ Markets: South Korean September CPI surprised on the upside (1.2% y-o-y; Aug: 0.4%), driven by food and housing prices; gains in core CPI were fairly modest at 1.3% y-o-y (Aug: 1.1%). This is unlikely to materially deter BoK from further easing, given the bank’s CPI target of 2% alongside the modest FY17 budget constraining upward growth and CPI momentum; eye another 12.5bps rate cut over 2016. Elsewhere, RBI unanimously delivered a 25bps rate cut to 6.25% under the newly-formed MPC. The bank expects India’s inflation outlook to improve on the better monsoon, while hinting downside risks to growth on the sluggish external demand. The increased focus on growth should keep RBI accommodative; stay constructive on short-dated Gsecs.

¨   USDJPY climbed 1.24% overnight on the USD strength, as investors look towards a probable FFR hike in the December FOMC meeting; FFR futures implied a c.61% probability of a rate hike. While the recent tweaks to BoJ policy tools may lack clarity, the bank have further room for rate cuts if the outlook deteriorates, although unlikely to drive any substantial weakness in the yen; stay neutral JPY.