Talking Points:
- The end of 2016 is in sight and it’s been a big year for markets. But before we get to New Years, there are still some very big issues to be addressed in the next week-and-a-half.
- Tomorrow brings a widely-awaited ECB meeting to markets, and the bar is already set fairly-high.
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This year has seen quite a bit of volatility across global markets and as many are well-aware, this volatility has begun to manifest itself in the political spectrum within some of the world’s largest economies. With 2017 lining up to be another big year, with French elections in April followed by German elections later in the year, we likely haven’t seen the end of volatility and for most intents and purposes, matters are likely just getting started.
But before we even get into 2017, there are some rather pertinent issues to be addressed. Tomorrow brings a widely-awaited European Central Bank meeting, and then next week brings on what is expected to be a vitally important Federal Reserve meeting in which the bank is expected to raise interest rates for only the second time in nine years. This morning, we’re going to address three of the most pertinent risk factors facing global markets right now.
Does the ECB Extend, End or Kick the Can (with QE)?
Last December’s ECB meeting was fairly dramatic.
As we moved into that meeting, the general expectation is that the ECB would further cut interest rates into negative territory. This would provide the luxury of enabling the ECB to buy even more bonds with their bond-buying program, as the yield ‘floor’ for which the bank could acquire bonds was their own deposit rate.
B ut 8 minutes before that expected announcement, a leak came out that indicated that the ECB wasn’t going to change rates at all. EUR/USD quickly spiked-higher as it appeared as though the ECB was going to disappoint, but when the actual meeting statement was released, the bank did announce a rate cut further into negative territory (albeit not as aggressive as what markets were looking for), and EUR/USD posed a quick-spike lower followed by an aggressive reversal-higher. But the point at which prices reversed is still relevant today as the spike-support at 1.0516 is continuing to help form near-term support.
Chart prepared by James Stanley
Over the next six months, EUR/USD rallied by more than 1,100 pips. The Fed began talking up higher interest rates in May, and this started to turn the trend lower; and last month’s gargantuan move in the U.S. Dollar drove the Euro from an election-night swing-high of near-1.13 all the way down to test that prior support at 1.0516.
At this point, the European Central Bank’s bond-buying program is set to expire in March of 2017. Many are expecting an announcement of an extension of this program at tomorrow’s meeting. The bigger question is whether any potential announcements might bring enough ammunition to finally take out the 1.0500 area on EUR/USD. As Chris Vecchio wrote in his morning piece, the ECB is walking in to tomorrow’s meeting with a high burden of proof.
Chart prepared by James Stanley
FOMC – December a Non-Issue, but How Many Hikes for 2017?
A rate hike from the Fed next week is widely-expected. We’ll probably have more problems at this point if the Fed does not hike next week, as the bank has been trying to prod rate expectations-higher for well over seven months now. The bigger question is 2017 and how aggressive the bank is expecting to be with rate hike plans.
This is what seemed to really freak markets out at the beginning of this year. As we came into 2016, Oil prices were threateningly weak, China was in a very vulnerable state and the Fed said that they wanted to hike rates a full four times in 2016. Within two weeks of the first rate hike in nine years and global markets had already begun to tip over.
The ‘pain trade’ lasted for all of about six weeks. That is, until Janet Yellen spoke to Congress on February 10th and 11th. This was her twice-annual Humphrey Hawkins testimony, and as you might imagine, the topic of interest rates did come up. On day one of that testimony, when asked about the possibility of negative rates, Chair Yellen responded that the Federal Reserve didn’t even know if that was legal. This raised alarm bells as it gave the appearance that, should markets continue collapsing, the Fed may be nearing the end of the ‘extraordinary measures.’ After day one of this testimony, markets continued to fall.
Chart prepared by James Stanley
But on Day two, Chair Yellen was asked the exact same question and her response was markedly different when she said that the bank was not going to take any policy options off-the-table. And this gave the appearance that the Federal Reserve would do ‘whatever it takes,’ very similar to Mario Drahi’s July 24th, 2012 speech in which he helped to arrest the European Financial Crisis. Near-immediately around those comments, support in risk markets came in and stocks began to rally again.
The next four months produced a near 100% move in Oil prices, stocks moved up to set even-higher all-time-highs, and by May – the bank was ready to talk up the prospect of interest rate hikes again.
This is where we’ve been for the past seven months, debating the efficacy of a single 25 basis point rate hike. But now that we’ve finally gotten to a space where data is strong, the underlying environment appears to be on more solid-footing and volatility in international markets has calmed, it would appear that the global economy is finally ‘ready’ for another 25 basis point hike.
But perhaps more pertinent, as what was proven to be more relevant last year, are the Fed’s expectations for hikes going into next year, which they will communicate via their dot plot matrix.
Oil – OPEC deal
Chart prepared by James Stanley
Oil prices have been a big story for the world in 2016. As we came into the year, Oil prices were mired in a +75% crushing that started in the summer of 2014.
The major issue was supply. As Oil prices had remained relatively consistent throughout the post-Financial Collapse environment while interest rates remained at record lows, considerable investment into R&D behind energy extraction created a whole new batch of supply that was previously-thought to be too expensive to extract. This created a groundswell (pun intended) of energy exploration and production in the United States that eventually saw the world’s largest consumer of Oil turn into one of the world’s largest producers (the U.S. has second-highest non-OPEC production of Oil, behind Russia).
As these new supplies of Oil came on-line, prices collapsed. Many of the economies that depend on Oil as their lifeblood suffered (like Venezuela, Russia, etc) and something had to be done. Right around the time that Chair Yellen had helped to bring support into the risk trade in February of this year – rumors began to float of OPEC coming together with some type of deal to cap production in order to keep prices high.
But this isn’t a simple prospect: This isn’t only a politicized issue, it’s a supra-national political issue that has had a tendency to produce rifts between countries as each member nation of the cartel is often looking after their own interests first and those of the cartel as a whole second. This makes for group decision-making processes to be even more complicated than they’d be otherwise and, historically speaking, this has a tendency to produce significant volatility around Oil prices.
Last week, OPEC finally announced the deal that they’ve been rumored to have been working on for the past eight months. Many of the details of that deal are rather questionable, at least at this point, and judging by Oil prices, markets aren’t yet convinced that this ‘deal’ will be able to substantiate significant price gains due to controlled supply in the months/years ahead.
As of right now – Oil prices are facing resistance. The next few weeks could be ‘big’ for the directional move in Oil, as this will likely show us whether markets are buying the fact that this recent deal may bring on some element of price stability or control.
Chart prepared by James Stanley
--- Written by James Stanley, Analyst for DailyFX.com
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