| Unstoppable flattening? - November bfinance rates and FX consensus |
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| 06/11/2005 | |
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Back-to-back rate hikes, high-priced long-dated bonds, and fears of an economic slowdown provide a ready mix for a yield curve inversion. Bfinance's November consensus points to a quasi-perfect flattening of the US yield curve at about 4.50 in six month's time. For now, the trend seems almost unstoppable. The Fed notched up its rate for the twelfth time in a row since June 2004, leaving Fed funds at 4%, dangerously close to the 4.53% yield on US 10-year bonds as of November 1st. Basing its decision on the short-lived economic impact of the hurricanes, monetary conditions and productivity gains keeping pace with the growth, as well as latent inflationary pressures, the Fed has been adamant in its "measured rates increase" stance. "Yet, the Fed is quite neutral and has not been as incisive as in its last release of September 20th", commented Philippe Waetcher, chief economist of Natexis AM in the wake of the Fed's decision. In the end, most economists pooled by bfinance still forecast a further quarter point increase at the FOMC's next meeting on December 13th. Two-thirds of them expect a subsequent hike in early 2006, which would push Fed funds to 4.50, achieving in the process a perfect curve flattening. "If the current relationship between long and short rates observed for over a year should last, a yield curve inversion would almost certainly take place", says Bruno Cavalier at Crédit Agricole. Inflation fears abound not only in the US, the Eurozone rate reached 2.5% in September. "This is an unbearable situation for the ECB", claims Marc Touati, an economist with Natexis Banques Populaires. "Under those conditions, the ECB is readying the ground for an upcoming hike of its refinancing rate. We think that a quarter point hike will take place next February, to be followed by one more increase in June 2006", he says. Even if that stance is not taken by many banks – only CCF and the Royal Bank of Scotland side with Natexis – the ECB's promise to exercise "strong vigilance" on the risks to price stability lends weight to this analysis. "[The ECB] concerns will only intensify as headline inflation heads toward 3%, propelled by higher energy prices", highlight Robert Gardner and Stuart Green at the Royal Bank of Scotland (RBS). "The risk of a precautionary move from the ECB some time during Q1 next year has significantly increased, not least because of the recent modest improvement in the growth outlook", add Gardner and Green. "Much will depend upon the upcoming round of wage negotiations, which provide an opportunity for the recent spike in inflation to become more widely embedded. However, we do not expect any near-term interest rate increase to spark a sustained programme of rate hikes – quite the opposite." That's leading RBS to expect a one-shot quarter point increase during Q1 next year. IN the UK, the Bank of England has been given much food for thought with the confirmation of the slowest growth rate in twelve years in the second quarter of 2005 (1.5% year-to-year). All banks – save one, Hypovereinsbank with a 25 bp decrease – bet on the status quo at three months. At six months, there is clearly the beginning of a downward consensus, with the median average now standing at 4.30%. In the FX field, the euro seems to keep holding value with an expected 2006 average level of 1.28, according to our consensus. "Beyond the support provided by the massive repatriation of US company profits and political uncertainties in Germany, fundamentals (trade deficit, strength of European equity markets, expected inflation) still point to a weakening of the greenback", says BNP Paribas' analyst. The euro is currently worth 1.22 US dollars. S.L. and J.L.  |
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