End of the era of low discount rates

According to the forecasts, yuan will continue its decline under the pressure of fundamental factors in 2016

The market has got what it wanted: FRS produced an account unanimously. The federal funds rate range was raised to 0.25%-0.50%. We can close up business and celebrate Christmas. It is only that Japan, China, and oil remain small irritants before the holiday. Global economies are shaping the course for rate increase. Statistically, the USA has been the first to break the monetary policy and, some time later, the main central banks of the word turn in the same direction.

New Year's forecasts and fluctuations is the basic theme of the FRS accompanying document. They are basically related to the growth of inflation, growth of GDP, reduction of unemployment, removal of restrictions regarding reverse REPO operations. Old girl Yellen looked extremely confident and amicable at the press-conference. Yes, rate increase is possible at every subsequent meeting. Yes, inflation is not important now. Yes, oil surprises with prices, but no growth of prices is required for inflation growth. Yes, we are tracking the situation with junk bonds; however, we are not apprehensive. Yes, in case of the absence of bad statistics, the global trend regarding the growth of US dollar will be preserved. Yes, if we have poor data, we will banish everything that is in the way and will adjust the data.

In general, the market has long digested all that, and the fall of US dollar following the FRS decision is a regular response to the closing of large volumes of long positions in dollar for fixation of profit at the end of the year. Many speculators stubbornly stuck to short positions in EUR/USD after ECB's decision, expecting profitable levels after the FRS meeting. It was particularly due to closing of those positions that led to the growth of euro at the second peak. Euro showed practically no response to the results of the Spanish elections where the current ruling party lost majority and will be forced to make a coalition with the opponents of the budget saving measures. The negative regarding the main currency will grow if the resolution of this issue is delayed.

The following of the other news will be noted:

  1. The US Congress unanimously approved the IMF reform on December 18. This decision should increase the role of the developing countries in the management of this organization. The issue regarding the support of this reform is a part of the US spending bill, and now funding of the American government until September 30 of the coming year has been practically resolved. This decision also allows to remove a corresponding ban on oil exports. Meanwhile Russia and China, by their quota size, remain in the top ten of the Fund's participant countries. According to the plans of this reform, the USA is expecting the decrease of SDR quota from 17.69% to 17.4% and the reduction of the number of votes (from 16.75% to 16.47%); however, the USA will still retain the right of veto regarding the IMF main decisions.
  2. The terms of the British referendum regarding Britain's participation in the European Union shifted from 2017 to summer 2016, and in the light of poor statistics on inflation and British labor market, large players are actively revising their forecasts towards the decline of GBP/USD, at least, by 2-3 figures for the 1st quarter of the coming year. On December 18, Britain closed Kellingley in West Yorkshire - the last coal mine in the country. By 2025, it is planned to close all "dirty" coal power stations, gradually replacing them with gas-powered and nuclear stations in order to reduce the effects of hazardous emissions and protect consumers from the growth of prices.
  3. On Monday, the Chinese regulator began to regulate the national currency for the first time after it was included into the IMF basket of currencies. According to the forecasts, yuan will continue its decline under the pressure of fundamental factors in 2016. Another amount of 30 bln yuan (4.7 bln US dollars) were added by the Central Bank of China to the current liquidity on Tuesday morning in the form of 7-day reverse REPO with 2.25% yield (last week, similar injections were worth of 10 bln yuans). Today, the outflow of the monetary funds from the country is a real problem for China; however, in general, the demand for yuan as a reserve currency on the part of the global central banks must grow continuously.

The Central Bank of Japan surprised the markets by introducing changes into the structure of assets purchased: it expanded purchases with the help of exchange investment funds securities (ETFs) by 300 bln yens annually, as well as it increased the term of state treasury bills that circulate in the framefork of QE program from 7-10 years to 7-12 years. The total volume of the Japanese QE program remains unchanged (80 trn yens annually). There are very few chances for further expansion of the QE program. Most of large banks were preparing their customers for the easing of the BoJ's policy in spring 2016; therefore, the market's disappointment was very big at the moment of the publication of this decision. However, there will be no global discrepancy between the BoJ and FRS policies, which, later, should lead to the growth of USD/JPY provided that the US has dynamics for economic growth and there are not any disruptions on stock markets.

This week, we should track the final GDP for the 3rd quarter on Tuesday and inflation of consumer spending on Wednesday as important US data. Downward revision of the data is expected, and the inflation of consumer spending (main issue for FRS decisions) is better than predicted.

EUR/USD. Regarding euro - very strong resistance in zone 1.0885/1.0911. In case of fixation above 1.1000, goals will shift: 1.1111/1.1129. The negative direction must take into consideration the existence of strong supports: (1.0840/ 1.0835) - (1.0766/1.0753) - (1.0723/1.0699). Both scenarios are unlikely. This week, there will be only three days of trading with unlimited liquidity; on Thursday, markets will be partially closed or trading sessions will be limited in time. Wednesday will be the last workday with unlimited liquidity.

Author: Alexander Ward,
ForexChief Currency strategist