Review and Preview
Ted Wieseman, US Fixed Income Economist, Morgan Stanley
Overall soft economic data in the wake of the weak employment report two weeks back and a further deterioration in European sovereign markets supported further small Treasury market gains over the past week, a fifth straight weekly rally that left yields near their lowest levels since early March at the longer end and February at the shorter end. These gains were accompanied and underpinned by a further dovish repricing of the Fed rate path in coming years ahead of Wednesday’s FOMC statement and forecast release and press conference. The pricing of the fed funds rate path in coming years is going into this FOMC meeting at the most dovish levels since shortly after the January 25 FOMC statement initially extended the zero rate guidance from mid-2013 to late 2014, extending a dramatic reversal of the misguided initial move in the aftermath of the March 13 FOMC meeting to price in a much earlier start to tightening. Treasury market gains since the March 20 recent market lows have closely tracked this major shift in the medium-term fed funds rate outlook, underlining that QE is only one of two key unconventional policy tools the Fed is currently employing. Market expectations at this point for an extension of Fed asset purchases after June seem to remain low, and we see less than a 50/50, though still highly data-dependent, chance of an extension of Operation Twist. But short rate policy guidance, when consistently and credibly reinforced by Fed leaders – as Fed Chairman Bernanke, New York Fed President Dudley and Fed Vice Chairman Yellen have done over the past month – has been proving to be the more powerful unconventional Fed policy tool. And the steady and cumulatively significant further fed funds futures repricing through the past week indicates that investors expected this message to be further reinforced by Wednesday’s FOMC meeting results.
FX: Higher Risk of Lower EUR/USD
Morten Helt, Senior Analyst, Danske Bank
This week’s ISM/PMI data painted an even more divergent picture between the eurozone and the US. While US ISM surprised on the upside rising to 54.8 in April from 53.4, eurozone PMI fell from 47.7 to 45.9 after the final revision yesterday (Wednesday).
Diverging economic development increases the possibility of further narrowing of the EUR-USD rate spread. This could be the game changer that could move EUR/USD out of the current very tight trading range, as further worsening of European data could trigger rising speculations about a new round of ECB stimuli, while falling US unemployment might increase expectations of an early Fed hike.
Further ECB Ahead?
John E. Silvia, Chief Economist, Wells Fargo
As widely expected, the European Central Bank (ECB) kept its main policy rate unchanged at 1.00 percent at its monthly policy meeting this week. However, the ECB’s description of the present state of the Eurozone economy was anything but rosy. The ECB said the economy has stabilized, albeit at a low level, but also stated that the outlook was subject to downside risks, most notably from the ongoing sovereign debt crisis. Although we believe the ECB will refrain from cutting its policy rate further, we acknowledge that further easing could transpire if economic activity remains depressed for longer than we anticipate. In that regard, the weaker-than-expected PMIs for the manufacturing and service sectors for April suggest that growth remains anemic, if not negative, thus far in the second quarter. Significant pressure on Spanish and/or Italian debt markets would probably induce the ECB to engage in another round of massive liquidity support to the banking system.
U.S. – Two Labor Markets Divided By A Common Ocean
Chris Jones, Economist,TD Bank Financial Group
Payrolls day gives economists a lot to talk about. Unfortunately, the conversation won’t be an ebullient one. Data released Friday showed the U.S. created a mere 115K jobs in April, after falling short of expectations in March. Across the Atlantic, eurozone unemployment hit 10.9% in March, the highest since the euro was launched over a decade ago. Worse still, Germany posted a surprise rise in unemployment, raising concerns that der motor of the European economy is starting to falter.
Compiled by David Song, Currency Analyst