The U.S. Dollar rose while equity markets declined on Friday following data that showed prices in the U.S. gained more than forecasts. The consumer price index gained +0.2% month-on-month in August higher than the +0.1% estimated while year-on-year prices increased +1.1% against expectations of 1.0%. A core measure of inflation excluding some of the more volatile items such as food and energy gained +2.3% higher than the 2.2% predicted. Lastly average weekly earnings adjusted for inflation increased +0.4% (YoY Aug) down from 1.2% previously. While the CPI measure of prices is not the Fed’s preferred measure of inflation, being the personal consumption expenditure (PCE) index, it certainly adds to the case for a rate hike in December but once again does not suggest the need for any urgent action by the Fed at this week’s FOMC meeting.
The Fed will release its monetary policy decision at 4am Thursday Sydney time and the key focuses will be the press conference by Janet Yellen and the economic projection updates known as the “dot plots” that will provide us with an updated path of the Fed’s interest rate expectations.
The reaction across financials markets was clear, the U.S. dollar gained +0.86% against a basket of currencies while both the S&P 500 & Nasdaq 100 fell -0.38% & -0.04%. Defensive sectors outperformed on the day, with both Utilities & Healthcare up +0.92% & +0.16% which are typically seen as predictable earners while Financials & Energy led declines down -0.92% & -0.84% respectively.
The decline in financials seems to be an interesting one given that stronger CPI increased the likelihood of a rate hike by the end of 2016 with higher rates leading to higher margins and improving banks profitability. This sector seems to have continued to be weighed down in sympathy to Deutsche Bank (DE:DBKGn) on news that the Justice Department is seeking $14 billion in fines over mortgage backed securities leading up to the 2008 GFC. Realistically this is the beginning of a long negotiation and as we have seen with settlements by other financial institutions, the end figures it is likely to be significantly lower. Share closed -9.35% weaker on Friday and the first chart below shows how this decline hardly even registers on the chart following a spectacular decline from its peak in 2007 at $159.73 from which it has never recovered.
The stronger dollar weighed on commodity prices, both WTI & Brent crude oil declined -2.0% & -1.76% respectively over concerns on increased supply from both Libya & Nigeria following the ceasing of internal conflicts. Copper prices were relatively flat, down just -0.02% while natural gas gained +0.71, both precious metals spot gold & Silver finished lower, down -0.28% 7 -0.87% respectively. An interesting move in commodities was a 6.9% gain in sugar futures on Friday which is shown on the second chart below. On Thursday there was news that the world’s largest producer Brazil may harvest a smaller than expected crop at which point prices gained 2% with the lack of news on Friday suggests that there is significant technical buying in the market.
European equity markets were also broadly lower despite no key data released on Friday. The Euro Stoxx 600 & DAX led declines down -0.74% & -1.49% respectively while the EUR/USD fell -0.77%. In the U.K. the FTSE100 finished -0.30% weaker as did the GBP/USD which closed -1.86% lower.
Despite a significantly stronger dollar on Friday the USD/JPY only declined by 0.2% ahead of Wednesday’s monetary policy decision by the Bank of Japan. A key focus from this meeting will be a report conducted by the BOJ into the effectiveness of its current monetary policy and this could have the potential to surprise markets. Overall market expectations seem relatively high for some type of action by the BOJ whether that is a cut deeper into negative territory, expansion of the current QE program or further lending to banks. It is very important for the BOJ to be seen acting and to send a strong confident signal to the markets that they will continue to do what it takes to achieve targets. This is true of all central banks in the world particularly where the decision to not act can have significant impacts across financial markets such as the ECB last week.
Japanese equity markets finished trading higher on Friday with both the Nikkei & Topix indices up +0.70% & +0.80% respectively. Domestically the Australian dollar closed -0.35% weaker while the ASX200 gained +1.08% after being heavily sold-off earlier in the week. Meanwhile the market looks set to open flat this morning with ASX SPI200 futures unchanged from Friday.
This article was written by James Woods - Global Investment Analyst, Rivkin Securities Pty Ltd. 