Markets Boosted By FOMC Announcement, Key Data From US, Sweden on Tap

The Fed expects years of low rates according to last night’s FOMC statement

Iran may decide to act first on the European embargo on its oil exports, putting further pressure on Spain, Italy and Greece in particular

Financial markets were boosted by the pledge for low US rates yesterday

Today sees the release of key economic data from the US and Sweden, which in case of the latter could prove decisive for the Riksbank's action on 16 February

Markets Overnight

Last night’s FOMC announcement set the stage for nearly three more years of loose monetary policy, as the statement called for rates to be kept “exceptionally low” until the end of 2014. This was more dovish than the market had expected and boosted sentiment towards the end of the US trading session. Notably, however, the wording does not imply that rates will necessarily be kept unchanged throughout this period, as  the first-ever published projections for the Fed funds rate revealed that 11 out of 18 members  expect
higher levels in late 2014.  The projections were published later in the evening and generally left a less dovish picture (see Flash Comment published 25 January).

Iran may decide to act first on the European embargo on its oil exports, according to Financial Times, by cutting supplies to the EU before the ban is implemented. The ban on crude oil imports agreed this week was planned to take effect from  1  July, giving particularly Spain, Italy and Greece time to find alternative suppliers. Energy prices have reacted by pushing higher, and while the embargo-related supply concerns were an important factor, the general rise in risky assets also played its part.

Chancellor Merkel presented no new cures for the debt crisis in a closely followed speech yesterday at the World Economic Forum in Davos. Rather, the German Chancellor offered no signs that Germany would pour further resources into the bail-out funds, letting down hopes following unconfirmed reports earlier this week that the EUR500bn cap on the European Stability Mechanism would be lifted.

US equity markets rallied, taking their cues from  the Fed pledge for low rates for several years. Furthermore, earnings announcements have generally been supportive for sentiment, with 74 out of 112 S&P500 companies reporting earnings above expectations, according to Bloomberg. The reaction in Asian trading has been mixed this morning.

Treasuries saw big moves yesterday, as the dovish FOMC statement drove the tendency for lower yields. However, the projections published later in the evening caused some of the move to be reversed.

USD weakened on the back of the dovish FOMC announcement, suffering both due to the correction lower in US rates and the overall pick-up in risk appetite.  This  led EUR/USD to break above 1.31 and caused USD/JPY to correct lower from the twomonth high reached yesterday, following a few days with unusually sharp price action.

Global Daily

Focus today: US initial jobless claims are expected to increase to 370K from previous week’s extraordinarily low 352K (lowest reading since July 2008). The underlying downward trend seen since September last year nevertheless seems to remain intact. Durable goods orders for December are expected to increase moderately following a strong increase in November and new home sales may gain pace giving further confirmation that the US housing market has started  to  improve (as also indicated by yesterday’s strong increase in the FHFA house price index). Consumer confidence data for Germany and France may confirm that a bit of optimism is returning to the euro area core countries. The Q4 reporting season continues with earning reports from Nokia, Hennes & Mauritz, Caterpillar and AT&T.

Fixed income markets: The Fed statement was more dovish compared to the market pricing prior, which initially caused a decent rally (lower rates) in the Fed funds futures. However, as the members’ projections revealed a high degree of dispersion, the read on the individual projections is less dovish than the FOMC statement suggested,  and  the rally reversed somewhat. Futures prices are now consistent with the Fed Funds rate being lifted to 0.50% by end-2014, compared to mid-2014 one day ago. As stock markets eventually performed during the evening session, it supported mild steepening of the 2-10s in the US. We still like the potential for steepening. Today the markets will keep an eye on the government issuance coming from Italy. We expect a total issuance of around EUR2.75bn. The auctions are not expected to rattle the markets given the current relief in financial conditions.

FX markets: Markets are likely to continue digesting the news from last night’s FOMC announcement. Given the overall dovish tone, the move higher  in EUR/USD could be extended further, though much will also depend on overall risk sentiment. This morning the rally in equities seems to be losing some steam. Note that today sees the release of a batch of Swedish economic data  that could be decisive for the February Riksbank decision. Hence, we look for the correlation between EUR/SEK and Swedish macro data surprises to stay in place. Also, keep an eye on the sovereign bond auctions today.

Scandi Daily

Sweden: Although Riksbank's Deputy Governor Wickman-Parak caused some volatility in the Swedish market yesterday as there were different interpretations about what she actually said in a radio interview and which were the reporter's own words, we still find it safe to say that she  at least acknowledged that mortgage lending rates have risen more than the repo rate, due to higher margins as well as higher funding costs for mortgage institutions and banks. Hence, we are inclined to believe that Riksbank is now addressing the "problem" we have been pointing to for some time, i.e. that the Swedish transmission
mechanism is out of order. More important, however, is the outcome of today's batch of Swedish data for the Riksbank's action on 16 February.

Our base case is that Q4 GDP will print -1.0% q/q, compared to Riksbank's forecast for +0.1% q/q. Actually, we think today's December data for trade balance, retail sales and unemployment may show that there is a risk of an even worse outcome, perhaps close to -1.5% q/q, to some extent a "payback" for the surprisingly strong Q3 figure. Nonetheless, we argue that a weak outcome would make it very hard for Riksbank to avoid a quite sharp downward revision to its GDP and inflation forecasts for 2012, paving the way for a February 25bp rate cut. We expect Riksbank to continue to deliver rate cuts to 0.5% by October this year.