Will Yellen soften Fed’s hawkish tone after US yields spike?

While equity markets appear to have broadly shrugged off last week’s US rate rise, bond markets have found it more difficult to do so, as concerns about an accelerated rate hiking cycle stay front of mind.

Initial concerns about an accelerated pace of Fed rate hikes were one of the reasons that prompted a sharp sell-off in equity markets at the beginning of this year, along with a number of other reasons. Even though this time markets appear a little more sanguine about the prospect, there is still a concern about the risks involved in pushing forward with such a strategy, and one of these is further sharp rises in yields.

The 10 year US Treasury bond has declined for six weeks in succession while the US dollar is already 4% higher than it was a year ago, as well as being 10% above its May lows, on a trade weighted basis. This is likely to act as a significant drag on US corporate profits, at a time when US stock prices are already richly valued.

While Fed officials haven’t done anything to disabuse the markets of multiple rate hikes next year, with renowned hawk Jeffrey Lacker of the Richmond Fed arguing that we could see more than three rate rises, the fact remains that it seems highly unlikely the Fed would be able to come close to that, given this year’s procrastination over a single rate rise.

In data out last week the recent expectations of a sharp rise in US interest rates may have played a part in the sharp 18.7% drop in housing starts, and 4.7% drop in building permits in November?

Today Fed Chief Janet Yellen will have the opportunity to elaborate further on her remarks last week in a speech in Baltimore, when she talks about the state of the US labour market.

As we head into the final full trading week of 2016, having come off a decent December so far for European stocks which have seen a number of significant breakouts, the key question as we head into year-end is whether these gains of the past two weeks are likely to be sustained.
Initial impressions look positive, however the elephant in the room remains the Italian banking sector after last week’s announcement by Italy’s largest bank Unicredit to draw a line under its recent problems by announcing a significant recapitalisation plan.

This week all eyes will return to Monte dei Paschi di Siena who are expected to launch their plans to sell €5bn of stock in the days leading up to Christmas to institutions and retail investors, in the hope that over €25bn of bad loans can then be sold on, and the bank rescued without having to bail in retail bondholders.

While the political picture at the top of Italian government has become a little clearer there is no reason that this particular attempted restructuring package is likely to be any more successful than the previous three, given the continued weakness of the Italian economy, which is probably why so far there has been so little investor interest.

Also on the agenda this week we have the latest Bank of Japan rate decision, where they will no doubt be very happy with the recent sharp fall in the yen against the US dollar, along with a slight improvement in recent economic data.

We also have the final iterations of US and UK Q3 GDP which are expected to confirm that both economies grew at a fairly decent clip in Q3.

EURUSD – a new multi-year low at 1.0365 has prompted a rebound but the risk of a move towards parity remains. To delay this prospect we would need to see a move back through the 1.0520 area and the lows this year.

GBPUSD – recent weakness has seen us slip back towards 1.2380 but it would need to see a move below 1.2300 to argue for a move back towards the 1.2100 area. Odds still favour a return towards the highs last week at 1.2670.

EURGBP – continues to find support just above the 200 day MA at 0.8310, which remains a key level. A break below argues for a move towards 0.8230. We need to see a recovery back through 0.8480 to stabilise.

USDJPY – continues to drive higher towards the 120.00 level, and likely to continue to do so while above the 115.60 level. A move back below 115.60 would then suggest a move back towards 114.00.

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