Afternoon analysis 09.10.2015:
The dollar dropped after the Federal Reserve's minutes. The chance for an extension of the zero rates policy supported risk appetite. Optimism remained strong in spite of hawkish comments from Dennis Lockhart. The zloty exploited the weakness of the US currency.
In the minutes of the September meeting the Federal Open Market Committee weighted the risk of a further slowdown in the global economy. The major concerns are the Chinese crisis and a further slowdown in the emerging market economies. Although the Fed is still willing to hike, it needs more proof that the US economy is resilient against the external factors. A strong dollar environment is hurting export (the latest data showed a larger than expected deficit).
Given yesterday's release, the Federal Open Market Committee appears to be rather wary. As a result, the recent deterioration of the economic releases from the eurozone (the German industry and export declined) will limit the willingness to hike rates. Thus, the likelihood of tightening dropped.
The market developments suggest that a similar view has prevailed among investors. The dollar dropped against the euro and other currencies. The EUR/USD moved near the 1.1380 level. Risk assets performed very well. The emerging market currencies and commodities also increased. However, given the latest speech from Janet Yellen and yesterday's comments from the San Francisco Fed President John Williams the current market mover is not well justified.
In late September, the Fed Chair diluted the statement after the Fed's latest meeting. Her remarks have pointed at a hike by the end of the year. It should have made the September minutes and statement not valid. Moreover, Williams ignored the labor market report. Thus, the current risk appetite is based on a weak basis.
According to Bloomberg data the probability of a rate increase in December is 39 percent. The likelihood of a hike in March 2016 is 62 percent. In contrast, 64 percent of economists surveyed by The Wall Street Journal are expecting a hike before the years-end. The rising discrepancy is getting more apparent.
Today Dennis Lockhart from the Fed supported the case for tightening this year. Although the Atlanta Fed President sees some deterioration in the latest data, he is still willing to raise rates.
In addition, mounting speculations that the European Central Bank is going to extend its quantitative easing may limit the euro appreciation potential. The latest reports from Germany signaled that the eurozone economy may slow down further.
The situation combined with low energy prices and the general weakness of the global economy limits the probability of the ECB to meet its inflation goal. As a result, the Frankfurt-based institution may act before the end of the year. According to the Bloomberg survey, a similar scenario was predicted by more than two-thirds of respondents.
The zloty exploited the opportunity
The risk appetite in the markets has been strengthened by the drop in likelihood that the Fed will hike rates. As a result, the major stock indexes increased. The commodity markets also posted gains. Resulting in the emerging market currencies posting a significant rebound after weeks of declines.
The rebound of the oil price supported commodity currencies. The Russian rouble posted a winning streak. The Turkish lira also increased. In the context of these currencies, the move may be stopped due to political risk. Moscow's intervention in Syria has been severely criticized by Ankara and NATO. If the tension increases, the rouble and the lira may return to declines. The zloty increase was smaller than the overall emerging market move due to the fact that the Polish currency is recently more steady.
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