Global financial markets were adjusting expectations for the monetary policy next year as three major central banks were gathering for interest rate decisions and economic outlooks - US Federal Reserve, Bank of Japan and Bank of England. It was hard to expect something new from BoJ and BoE as local economies did not show any significant shifts in macroeconomic data recently. In contrast, meaningful shifts were widely anticipated in the Fed’s rhetoric as investors were expressing disagreement with policymakers, forcing them to stop the tightening cycle. The Federal Open Market Committee (FOMC) disappointed global market players, keeping the hawkish tone and promising more interest rates hikes next year which triggered another brutal sell-off in US equities. All of the three major stock indices plunged in the United States after the interest rates decision and monetary policy statement, expanding the negative yearly result. Last week’s performance was one of the worst in a decade, the last time such a bloodbath has been noticed in 2008 during the last financial crisis. S&P500 lost 7.43% of its value, Nasdaq plunged for 7.95%, while DJIA was down by 6.43% as the weekly trading result. US 10-year Treasury yields eased to 2.792%, lowering the third consecutive week. Moreover, the spread between 10- and 2-year yields narrowed even more, down to the lower rate in ten years. That change in the yield curve direction traditionally signals an upcoming recession for the leading world’s economy as the fixed-income market investors start to outperform the corporate sector and equities.
The Federal Reserve Chairman Jerome Powell could listen to the private sector which was insisting on a break in the tightening cycle, underlying the negative impact of too much tightening in the financial conditions. The problem is that it’s getting harder to fund the corporate debt which has enlarged recently during the bull market rush when investors were buying stocks after the tax reform. The main justification for regulator’s tightening measures was related to the inflationary pressures which were forecasted to accelerate. However, that expectations were not confirmed as the latest CPI and PPI reports,as well as PCE price deflator, showed a slowdown of the inflation. What was the reason for another rate hike then, the fourth time this year and fifth consecutive quarterly hike? Fed Chair Powell wanted to show the regulator’s independence from politicians which were pressuring the monetary policymakers recently. By the way, Donald Trump was frustrated right after the Fed’s rate decision and the followed market reaction, according to official unanimous sources. He even wanted to fire Powell as he already did with many previous White House top-managers. There are questions, of course, about the legal opportunity to do so for US President, but still...
One of the key reasons for such a massive market’s reaction on the FOMC statement was related to the regulator’s plan to keep the balance sheet reduction by the same amount of $50 billion monthly, while many economic experts noted that an amount of 25 billion would be more than enough to keep the healthy shape of the economy. That quantitative tightening, as it’s been called by analysts, does not correspondent to the current situation in the economic growth which started to show first signs of slowing down. Moreover, it might hurt the economic growth, widening the negative impact of too tight monetary policy. One more factor of investors’ and politicians’ frustration is that the Federal Budget deficit keeps growing together with the negative trade balance in the United States. The higher level of borrowing costs makes that double deficit more expensive to fund, forcing US Treasury to go on the external borrowing market with worsening conditions. All of that pressures on investors’ confidence in the leading world’s economy, enlarging changes for an upcoming crisis in 2019. There has been a similar example in the past when Alan Greenspan hiked the interest rates by 25 basis points in deviation to the private sector’s opinion. The equities market reacted with the sell-off, exactly like this time. Greenspan fixed his mistake and never did that again.
The impact of such an unexpected hawkishness by the Federal Reserve was also dramatic for the currencies market. The US dollar was weakening slightly before the rate decision and the initial reaction was to reverse, as further rate hikes would have caused an additional demand for the greenback among currency speculators and fixed-market income. However, the US dollar accelerated its plunge versus most of the major currencies, breaking the convergence with US stocks which has been seen throughout the whole year 2018. Currency traders also realized that the tightening might hurt the economic growth in the United States, selling the greenback heavily. The single European currency reached the highest level in 6 weeks around 1.1485 on Thursday after the financial world understood the possible consequence of a wrong decision by the Federal Reserve in conditions of a global recession next year. Some good news from Italian-EU negotiations were supportive of EUR/USD, however, there were not much of the macroeconomic changes in the Eurozone ast week, and the pair failed to hold the gains, sliding below 1.1400 psychological support on Friday.
Safe heaven Japanese Yen surged with USD/JPY plunging to 111.00 yen per dollar in brutal Thursday’s sell-off, the first time since September 2018. All of the commodity currencies were weakening with the Canadian dollar leading the losses, as USD/CAD approached to the resistance at 1.3600, the first time in 18 months. Other high-yield commodity currencies, such as Australian and New Zealand dollars, weakened versus the greenback as the overall risk aversion hit the highest level in almost a decade. Two of the most lucrative cross-rates to trade last week were CAD/JPY (-294 pips or 3.47%) and NZD/JPY (-252 pips or 3.27%).
The Bank of Japan was gathering for the interest rate decision on Thursday, right the next day after the US Federal Reserve. Japanese monetary policymakers were trying to fix the situation, calming investors down with verbal interventions. BoJ kept the interest rates at the same ultra-low levels, injecting more liquidity into the financial system. The supportive measures are aimed to help exporters competing on the external markets by lowering the borrowing costs. However, the panic was so strong that BoJ was completely ignored and USD/JPY kept falling. The key Japanese stocks benchmark, Nikkei 225, was declining by 1.86% on single-day trading on Thursday, finishing the week with an ugly performance of -5.73%.
The Bank of England did not surprise investors on Thursday, leaving the interest rates unchanged. All of the 9 voting members of the Monetary Policy Committee did not change their mind, and the regulator published a dovish economic statement as most of the macroeconomic data were weak recently. The Brexit vote in British Parliament has been postponed till January and it supposed to mean that no news is bad news for the Sterling. However, given the speed of the greenback's plunge across the board, the British Pound managed to gain strength versus the US dollar last week with a modest result of +0.46%. Such a sudden bullish performance could be explained with the fact that currency speculators just shifted their focus amid sudden turmoil in other markets. Further weakness for the cable is still possible, especially versus Japanese Yen and Euro.
In other markets, safe-haven gold was surging 1.39%, breaking through $1255 per ounce. There is nothing surprising, given the risk aversion trade and equities’ turbulence. Other commodities including industrial metals were weakening on global trade fears. WTI Crude oil led the losses, declining by another 11% last week. The price of oil tested $45 per barrel, the lowest rate in 15 month due to three reason: global demand kept lowering its forecasts, OPEC members failed to agree with Russia on supply cut, while the US shale production continued to beat all of the forecasts, growing at a much higher pace despite the lower oil price. All of that situation reminds the market crash in summer 2014, and we might see new lows in oil prices next year if that continued.
Friday brought another brutal sell-off in US equities after Defence Secretary Mattis resigned and politicians failed to agree on the Federal Budget. Trump refused to sign the bill, triggering the government shut down in the United States, the second year in a row during Trump’s presidency. The triangle of White House - House of Representatives (controlled by Democratic majority) - Senate (with Republicans in charge) is going to try to resolve the current situation in order to fund salaries for the budget sector at least. The main question of the conflict is related to the border issue, as the President wants to make his election promise while Senators cannot find enough money for the Wall. Is it really needed so much in this environment?
As a result, US stock indices got hammered with another heavy daily sell-off on Friday after early attempts to recover some of the mid-week losses. The distance between the daily peak and bottom underlines the enprecedented volatility influencing the equities market. Although, it was rather strange to observe the US dollar surging across the board, looking at the things happening in the United States. Profit-taking flows before the Christmass week together with safe-haven flows for the world’s reserve currency left a bunch of question about the greenback’s trend during the rest of the year and beyond. Unfortunately, Such a volatile price action only confirms the fact that the global financial market is heading into a scary crisis in 2019.