Strategy Report, Uncategorized

Central Bank Rate Decisions Outlook

Federal Reserve Rate Decision Outlook:
Rate hike expectations for the Federal Reserve remain muted as commentary by Chairman Bernanke and others alluded to a prolonged period of “exceptionally low levels of the federal funds rate for an extended period.” Prior to raising the target rate, Fed officials are likely to wait until after programs meant to boost credit and liquidity reach their end in Q1 2010. This includes $1.25 trillion in agency mortgage-backed securities and approximately $175 billion in agency debt, as well as other initiatives including funding and lending facilities. Trading action in Fed Funds futures imply that June 2010 may be the first meeting in which an increase of any sort is foreseen by a majority of investors. Despite speculation, a decision to raise rates will be contingent on whether the FOMC revises higher its expectations on growth and inflation. Certainly, inflation fear remains suppressed although the core CPI, a commonly used gauge for price growth, has crept up to 1.7% in October from a low of 1.4% in August.

Bank of Canada Rate Decision Outlook:
Bank of Canada officials have maintained borrowing costs at 0.25% on concerns that the appreciation of the Canadian dollar may offset the recent rebound in economic activity.  After the central bank’s October policy meeting, forecasts were adjusted slightly higher for economic growth through 2009 and expansion for 2010 was forecast at 3.0 percent.  Price levels, however, are expected to remain below the 2% inflation target into 2010 so hawkish policy is unlikely at this time.  Investors are not pricing in any chance of a rate hike according to Credit Suisse overnight index swaps and Governor Mark Carney remains committed to the current low rate through the second quarter of 2010.

European Central Bank Rate Decision Outlook:
The Governing Council has kept the ECB rate at 1.00% for the past seven months, while President Jean-Claude Trichet has cited recent economic improvements in the euro area.  Real GDP returned to growth in the third quarter following five quarters of contraction, with bank officials projecting positive real GDP growth in 2010 and 2011.  Despite this positive forecast, the market currently prices in no expectation that the ECB may move rates 25 bps at the next meeting.  This is likely due to the ECB declaring that the outlook remains subject to “high uncertainty” and “low inflationary pressure” over the medium term.  However, President Trichet may be preparing for a future rate hike after the ECB’s decision on December 3 to end long-term emergency loans and tighten the terms of its final 12-month tender.

Bank of England Rate Decision Outlook:
BoE officials have maintained the benchmark rate steady at 0.50% for eight consecutive meetings and voted to increase its £175 billion asset purchase program to £200 billion.  The UK’s economic recovery has struggled to gain footing as GDP contracted 0.4% in the third quarter and the jobless rate sits at 7.8%.  According to central bank officials, “financial conditions remain fragile” as lending remains tight and spending still weak.  Market participants currently price in no expectation that the BoE will hike rates by 25 bps at the next meeting as the economic recovery looks to gain traction and price levels remain tepid.  Looking forward, however, the market expects a 69 bps increase in the benchmark rate as the central bank has concerns that inflation will rise in the medium- to long-term.

Swiss National Bank Rate Decision Outlook:
The Swiss National Bank has maintained its target rate at 0.25% (with a range between 0.00% and 0.75%) for a full year as the economy was struggling to recover and price levels remained low.  In the third quarter, however, Swiss GDP grew 0.3% after yearlong contraction.  Investment rose by 3.4% in the third quarter, its largest increase since 2003, and exports climbed 2.6% after falling 2.2% in the second quarter.  Exports, essential to the Swiss economy due to weak domestic demand, rose thanks to improving economic conditions for European trade partners and a stabilized Swiss Franc.  Looking ahead, the SNB will likely be slow to raise rates due to concerns over weak consumer demand and rising unemployment.  There is currently no market expectation of a rate increase at the next meeting and only a 31 bps increase over the next twelve months.

Bank of Japan Rate Decision Outlook:
In an unscheduled move in December, Bank of Japan official decided to ease monetary policy further with the introduction of a new funding operation of three month loans expected to reach a maximum size of ten trillion yen. The key rate has been held at 0.10% since the end of 2008, and given the central bank’s tendency in the past, along with persistent deflation; an increase is not expected in the year ahead. Indeed, core CPI in October posted a fall of 1.1%, the largest contraction in prices since recording began in 1971. Another factor hampering rate hike expectations is economic growth, with GDP up just 1.2% in preliminary third quarter readings while bank lending slowed to a 1.9% annual increase.

Reserve Bank of Australia Rate Decision Outlook:
The RBA shows few signs of slowing down its tightening policy as the central bank raised the cash rate for a third consecutive time in December. The decision to increase the rate by twenty five basis points to 3.75% came amid significant improvements to the economy, one of few major nations that narrowly avoided recession. To their credit, Governor Stevens cites regional financials with lower toxic assets that enable quicker recovery in credit markets. Also supporting growth has been the A$42 billion in fiscal stimulus. The OECD now expects the economy to expand 0.8% in 2009, and while inflation remains a concern, the RBA stated that recent “material adjustments” will consumer prices in check. Consequently, investors’ expectations for rate hikes have declined sharply, from 12-month expectations of 216 basis points increase to 102 basis points early in December.

Reserve Bank of New Zealand Rate Decision Outlook:
Since lowering the official cash rate to 2.5% on April 30, 2009, the RBNZ has refrained from raising the key rate even as GDP climbed for the first time in over a year. The economy grew in the second quarter at a 0.1% pace, with further expansion possible as retail sales climbed for in the third quarter. While neighboring Australia began to tighten rates to avoid an inflation threat, Governor Bollard of New Zealand sees no cause for concern as CPI remained below two percent in the past two quarters. Market participants have pared their bets, expecting 163 basis points of increase in the next twelve months, down from expectations of 235 basis points in late October. Ultimately, the bank has remained adamant in its latest meeting with no intention to change the OCR “until the second half of 2010″.

Written by James Russell and Roman Kadinsky, CFDTrading Research