Markets

The major event of the past week was the US Fed’s decision to raise interest rates by a quarter of a percent and signal that it will continue to hike until 3% is reached. They have every reason to do so as economic indicators continue to show strength and inflation, although not out of control for the moment is close to the FED’s target range. Indicators of demand such as retails sales, manufacturing PMIs, housing market, employment and wages series all do not show any signs of deceleration. Data on Non-Farm payrolls should confirm the trend this week. It is interesting to note that the hike in rates did not invert the yield curve and the spread between the 10 year minus the two year treasuries, a leading economic indicator, closed at 24 basis points as the long end rose (see above chart). An inversion of the curve is an indicator of a recession which clearly is not on the cards for the time being.

The decision of the FED will have an impact on Europe, the second largest currency bloc, which may now be forced to review its monetary policy trajectory in light of the former’s newly disclosed objective. It is likely now that the ECB will taper sooner than thought forcing a rise in the EUR against the greenback to levels forecast by some analysts to be above the 1.20 threshold with a steeper yield curve in the next twelve months. The improvement in the manufacturing PMIs in Europe noted since the past months did not show signs of breaking out to the upside yet as data this morning in Germany, Spain, Italy and France remained soft. The Italian budget deficit forecast last week leaves the country exposed to downgrades by rating agencies.

In China, the Caixin manufacturing PMI shows further deceleration as anticipated as the forced fiscal moves after the trade war escalation at the start of the year starts to show up in economic activity.