FOMC Minutes Highlight Concerns

Daily Analysis - 07/01/2016

Federal Reserve Policymakers Unanimous Decision to Raise Rates Overshadowed by Weak Inflation

The latest FOMC Meeting Minutes from the December decision underline the fact that despite policymakers were unanimous in the move to begin the process of monetary policy normalization, concerns about the pace of inflation remained a real worry with the benchmark missing the targeted 2.00% for the last three and a half years.

Fed Wary of Dollar Strength

Alongside fears that inflation will not rebound substantially enough to justify further interest rate hikes in the coming quarters was the notion that the strength of the US dollar would hinder positive economic momentum and keep inflation subdued. Robust job creation might be a source of upward pressure on inflation, policymakers are wary of the global disinflationary environment, especially amid the substantial losses in energy prices. While the meeting minutes highlighted that the December decision was indeed a close call, right now, Fed Funds futures are currently pointing to a 45.00% probability of another rate hike in March. Nevertheless, uncertainty surrounding inflation continues to be a sticking point for policymakers as they intend to normalize monetary policy. The US dollar continues to post gains against most major peers, gaining substantially versus the Canadian dollar on the back of losses in oil prices.

Chinese Markets Close After Steep Losses

After attempting to reassure financial markets with a liquidity injection earlier in the week, Chinese policymakers are once again standing face to face with startling losses in equities after stocks fell by another 7.00% for the second time this week. Stocks were halted twice before the market was shut down for the rest of the session, raising fears that confidence boosting measures were not enough to prevent the slide. Although the Yuan has recovered modestly after yesterday’s substantial devaluation move by the People’s Bank of China, preventing capital outflows from the mainland has become of chief concern. Losses in stocks are showing that sentiment is broadly worsening and unlikely to reverse over the near-term until more aggressive easing measures are implemented such as lower interest rates and reduced reserve ratio requirements for banking institutions.

Oil Prices Hit Multi-Year Lows

Despite inventories falling by a substantial amount in the latest Department of Energy report, crude oil prices continued to fall overnight, with Brent and West Texas Intermediate both hitting fresh multi-year lows. According to the Energy Information Administration, US crude oil stockpiles fell by 5.085 million barrels last week in a sign that year end drawdowns were substantial ahead of the month of January which traditionally sees inventories grow. However, despite falling inventories, stockpiles at Cushing rose for the ninth straight week while production also climbed by 20,000 barrels per day. Despite lower prices, output remains resilient and moreover, the drawdown in inventories failed to catalyze even a modest rebound in crude oil prices. High refinery utilization rates might be partly behind the sustained drop in prices with distillate and gasoline inventories soaring in the last reporting period, evidence of weaker demand.

ADP Highlights Employment Bright Spot

Even though Federal Reserve policymakers were concerned about the pace of inflation, job creation is showing its own durability after ADP reported a stronger than anticipated rise in nonfarm employment during December. The largest private US payroll processor figures showed 257,000 jobs were added, surging past expectations of 192,000 and the prior figure of 211,000. Although not perfectly correlated with Friday’s nonfarm payroll figure from the Bureau of Labor Statistics, it provides a strong indication that the prevailing trend higher in employment metrics are likely to see further improvement. At present, consensus estimates put the official nonfarm payroll figure at 200,000 jobs added in December with the unemployment rate forecast to hold steady at 5.00%. The reaction to the positive ADP figure was a rally in the US dollar, with even USDJPY reversing higher temporarily before resuming its downward slide.