Fed Funds pricing suggests odds of a hike by December are just above the 50% mark; yields continue to rise across the curve; USD mostly up across the board; NZD down 0.6% to 0.7260 USD; local rates higher and steeper

By Jason Wong

The USD and rates are higher as the market positions itself for the FOMC meeting later in the week.  Trading conditions are fairly quiet and that may remain the case until Thursday morning’s important update from the Fed.  The consensus expects the Fed to announce the beginning of “quantitative tightening” (QT), with its balance sheet expected to begin shrinking from next month, initially at a pace of $10bn, and the Fed to keep its options open for another possible rate hike in December.

Fed Funds pricing suggests that the odds of a hike by December have been ticking higher over recent sessions and are now just above the 50% mark.  Yields continue to rise across the curve, with the US 10-year Treasury rate up another 2bps to 2.22%.  Since bottoming out just over a week ago when Hurricane Irma fears were at their greatest and US-North Korea tensions were higher, the 10-year rate has piled on about 21bps, while the 2-year rate has piled on 14bps to 1.39%.

Yesterday, US Secretary of State Rex Tillerson said that the US seeks a peaceful resolution to the tension with North Korea, but is prepared to use military force if diplomatic efforts fail to end the nuclear standoff.  This has helped support the risk-on environment, which sees the S&P500 up to another record high.  Trump’s first address before the United Nations is tonight, so there’s no guarantee these benign market conditions will sustain another day.

The USD is up mostly across the board, with the TWI majors index up 0.3%.  The CAD has taken the biggest hit, with USD/CAD up 0.9% to 1.2310 after Bank of Canada Deputy Governor  Lane said that  policy makers will be “paying close attention” to how the economy responds to higher borrowing costs and a stronger CAD, following rate increases in July and earlier this month.  The comments raise a question mark about the next possible rate hike, given the strong run in the CAD recently.

GBP is down 0.7% to 1.3490, with some traders taking profits after its surge post the BoE’s surprisingly hawkish tone last week.  The fall came ahead of a speech by Governor Carney and the currency fell further after that.  While he stuck to the line that some BoE tightening may be needed in coming months, he indicated that rate hikes will be “limited and gradual” and noted there remains “considerable risks to the UK outlook”.  He recognised the slowing in growth as the Brexit process begins but he also suggested that UK potential growth had also fallen as a result, and this partly explains why the MPC now says it may need to raise rates soon.

USD/JPY is up 0.5% to 111.40, with the higher bond yield (risk-on) environment not helping, and the yen also suffered after reports that Prime Minister Abe may call a snap election when he returns from the US, with a vote potentially coming in October. This could be a risky move for him.

After the NZD’s likely flow-driven push higher up through 0.7340 yesterday afternoon, it has been all downhill since, as the USD has been in the driving seat, with the NZD down 0.6% for the day to 0.7260, almost a full cent off its high.  The AUD has tracked a similar path, and is down 0.6% to 0.7955, with NZD/AUD up a touch to 0.9125.  All the event risk this week is concentrated on Thursday, the same day as the FOMC meeting, with NZ GDP, a speech by RBA Governor Lowe and the BoJ meeting the same day.

There’s little to add on EUR, with the currency one of the few to hold its ground against a solid USD.  EUR is flat at 1.1950.

NZ rates continue to follow the higher and steeper path of the global rates curve.  The 2-year swap rate rose by 2bps to 2.23% and the 5-year and 10-year rates rose by 5bps to 2.73% and 3.24% respectively. The market is now pricing in the first full RBNZ rate hike around September 2018, which in practice means a toss-up between the August MPS (BNZ economists’ view) and the November MPS.  This is understandable.  In a world where the major central banks are tightening policy it would be highly unusual for the RBNZ to be standing pat.  It’s all looking like a repeat of the late-June sell-off in rates, with global central banks in the driving seat. 

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