FED’S HAWKISH RATE HIKE
The Federal reserve raised its short term rate to a range of a 0.50-0.75% from a range of 0.25-0.50 % and signaled three increases in interest rates in 2017 instead of two and it expects to raise rates much faster in 2017 than previously anticipated. According to Federal Open Market Committee (FOMC), inflation has increased since earlier this year, but still below the Fed’s 2% longer-run target, partly reflecting earlier declines in energy prices and in prices of non-energy imports and labor market has continued to strengthen.
The dollar reached the highest level since January 2003 after the Federal Reserve (FED) hiked interest rates in first move since 2015.
The US 10 year treasury yield curve has steepened further and climbed above 2,5 and reached the highest level since 2014 after the fed hawkish rate hike. After gains, US dollar and treasury 10 year yields fell from peaks today. As you see from the chart below, the treasury curve is steepening and flattening at the same time.
On the other side, U.S housing starts and building permits fell more than than expected, released today. US inflation rose to 2 year high and reached the highest level since October 2014. Moreover, according to Markit, US factory activity growth improved at 21 month high.
FED RATE HIKE-RISING OIL PRICES-THE STRENGTHENING DOLLAR-VOLATILITY : DRIVE CAPITAL OUT OF THE EMEs?
Expectations of raising fiscal spending under Trump presidential and the price of oil rising will bring the inflation and the FED will increase the interest rates aggressively in 2017. Thus, emerging markets started to worry about rising interest rates, in other words, higher funding costs of debt. Some emerging markets are still suffering large external funding needs and macroeconomic imbalances which lead them to be vulnerable to capital outflows. For example, Turkey, Brazil, Indonesia, Mexico, Russia and South Africa are the most sensitive to high capital outflows, comparing to other EMEs. These countries also have high credit default spreads (CDS). In other words, they have high risk of default.
Good news for Russia / oil producing country: Russia CDS spreads have tightened due to rising oil prices after the OPEC deal to cut production. (The risk of default is decreasing/will decrease in Russia)..
LESS ROOM FOR FURTHER US DOLLAR APPRECIATION FOR EM CURRENCIES
EM currencies tumbled from 25% above fair value in 2011 to 30% below fair value in January of this year.
Although EM currencies, represented by the JPMorgan Emerging Local Markets Index Plus, have rebounded since January 2016, they continue to trade near the discounts associated with the 1997 “Asian Contagion” and 1998 Russian debt default. EM currencies can certainly get cheaper before they revert toward historical norms, but they might just as easily snap back quickly to fair value.
EM RETURNS CONTINUE TO RECOVER UNTIL NOW
JAPAN – WEAK YEN = INFLATION
Higher oil prices after OPEC deal and a weak yen since the Trump’s victory may help Bank of Japan (BoJ) reach its inflation target in 2017 even if it seems difficult. Japan CDS spreads are tightening and seems that the risk of default in Japan is very low.
ABENOMICS AND GROWTH
China’s Currency Manipulation- Sharp falls in the value of yuan-Hong Kong overnight costs
China 10-year government bond yields keep moving higher and CDS spreads are widening..
It is always good to be reminded about CHINA..
Eurozone bond yields climbed to hit 11-month high in FED week. After climbed, they started to fall as fed price hiked in..
RECAPITALIZATION OF ITALIAN BANKS-NEW PRIME MINISTER -NO PROBLEM AT ALL?
New Italy PM Gentiloni says ready to intervene to support banks. Unicredit: Italy’s largest bank is raising 13.8$ billion in the country’s biggest share issue and cut jobs in overhaul. Moreover, Unicredit sells Pioneer asset management arm to Amundi for more than 4.2$ billion..
GOOD NEWS BEFORE CHRISTMAS: Monte dei Paschi wins approval for debt-for-equity swap to retail investors is a crucial element of the plans to raise €5 billion in the coming weeks.
Italy CDS Spreads continue to tighten significantly as recapitalization of banks, but still has high risk of default more than Spain, Germany and France.
Lastly, S&P warned that Italy GDP growth to fell below %1 over next two years after banking pressures.
EURO – UNDER PRESSURE/THE REACTION TO THE FED’S HAWKISH RATE
EUR/USD dropped 1 % after the fed rate hike.
The Euro area economy has improved in the third quarter and inflation is increased by 0.6% yoy in November 2016. According to Markit, businesses across the euro zone ended the year on an upbeat note as expected and weaker euro boosts price growth and manufacturing.
Pound had fallen sharply against the dollar on Thursday as Fed hike priced in. FTSE100 closed above 7000 on Friday as rising energy stocks. UK inflation hit 1.2% yoy in November 2016 as jump in oil prices during 2016 and Bank of England leaved UK interest rates on hold at 0.25% . Source: ONS
UK risk of default probability continues to decrease after Brexit shock..
OIL: CONCERN ABOUT POTENTIAL PRODUCTION INCREASES IN THE US AND LIBYA
Oil prices have risen after OPEC cut deals with non-OPEC member countries. However, continued dollar strength can reduce the demand for oil, especially in emerging economies.
SUMMARY: LATEST CDS 5 YEAR SPREADS
Source:Markit CDX credit default swap indexes cover North America and emerging markets. Markit iTraxx credit default swap indexes cover Europe, Asia, Australia and Japan. The indexes are owned, calculated and administered by Markit. For more information visit www.markit.com/cds