Perspective: Morning Commentary, 12/17/2015

Thursday, December 17, 2015


December 17 – The Fed effectively managed market expectations Wednesday, while initiating its first rate liftoff since 2004. Market reaction was far better than for its counter-parts in Europe earlier in the month when the European Central Bank merely expanded its asset purchasing program rather than expanding it as expected. The Fed took a hawkish stance into the December meeting, met expectations, but then talked traders off the cliff resulting in a rise in the equity markets.


I would be among the first to argue that the Fed should not be concerned about Wall Street reaction, because that can lead to bad policy reaction. However, its comments and behavior in recent years would suggest that it is very concerned, with that concern likely heightened after the ECB debacle earlier this month.


The Federal Reserve raised its key rate by 25 basis points, which was then followed by a dovish statement and comments by Chair Janet Yellen as expected. That initially led to some uncertainty in both the currency and stock markets, but then traders took note that the unanimous Fed vote suggested support for sustained liftoff, with the Fed median target rate for next year at 1.375%. That suggests we could see another 100 basis points added to the key rate over the coming year; equivalent to four 25-basis point hikes between now and the end of next year.


That put a hawkish lining on the dovish cloud Yellen tried to portray when she talked of slow tightening. The dollar reacted by pushing higher, raising prospects that we could see it test its recent 12-year highs in the weeks ahead. The stock market meanwhile interpreted the Fed’s actions as suggesting that the economy must be healthier than it feared, resulting in strong gains for the day.


Argentine made news again late on Wednesday when it loosened controls on the peso, allowing it to float to market value. Newly-elected President Macri would like to close the gap between the official trading rate for the peso and its black-market rate, suggesting that the peso needed to fall more than 30% to find its “true” value. That combines with the elimination of corn and soybean export taxes to make Argentine grain much cheaper on the global market.


Macri hopes that the move will spur an increase in Argentine farmer selling of cash grain, resulting in a net increase in the flow of foreign reserves into the country that can be used to pay that country’s debt. He also hopes that the increased farm selling will increase farm revenues, resulting in higher income tax revenues into the government treasuries. Wednesday’s actions triggers one of the true big tests for the new administration on whether it will be able to successfully implement it market-reforms and survive the political fallout that is sure to come.


We continue to monitor weather developments in Brazil’s northern belt. Once again, rains need to verify early next week to prevent deficits in northern and eastern areas from growing to levels that would increase crop stress to a third of the belt. That has been the case for several weeks, but thus far just-in-time rains continue to maintain yield potential in all but about 15% of the belt.


Look for the trade to increasingly take on a holiday look. Many traders will be squaring positions ahead of the weekend to take extended time away from the markets, with the trading week shortened in each of the two remaining weeks of the year. Index fund portfolio rebalancing occurs once we turn the calendar to 2016, followed closely by USDA’s big January 12 crop report known for its surprises. We should know a lot more about the South American crop potential by then, with traders also starting to look ahead to the anticipated impacts of a waning El Nino on the U.S. Midwest growing season.


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