Global Daily – Fed keeps rates on hold

by: Maritza Cabezas , Fouad Mehadi , Kim Liu

US Macro: FOMC keeps rates on hold and leaves door open for a rate hike in June

The FOMC’s statement delivered after the 3 May meeting showed a positive tone, despite the recent weaker data. The adjustments made to the statement tried to capture the strong underlying economic fundamentals, while suggesting that the economic slowdown is likely to be transitory. We think that with this message, the FOMC is trying to leave the door open for a rate hike in June. Indeed, ‘the Committee views the slowing in growth as likely to be transitory and continues to expect that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace. On consumption the statement mentioned that household spending rose modestly and emphasised that ‘…the fundamentals underpinning the continued growth of consumption remained solid’. On inflation, which was weaker than expected in March, the statement mentioned the recent decline. However, it added that ‘inflation measured on a 12-month basis recently has been running close to the Committee’s 2 percent long-run objective’. As expected no changes were made to the phrases regarding the FOMC’s strategy for the Fed’s balance sheet. Ahead of the release, the Federal funds futures, the odds for a rate hike in June were 70% and after the statement the odds jumped to around 93%. At the end of the week we will have a few Fed speakers and it will be interesting to see if they give more signs on the pace of rate hikes in the coming months. We still expect two rate hikes this year, one in June and another in September. (Maritza Cabezas)

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Euro Rates: The seamless transition from quote to transaction-based Euribor – On Thursday 18:00 CET, EMMI (European Money Markets Institute) will publish the results of its ‘Pre-Live Verification Program’. The ‘Pre-Live Verification Program’ is part of a preliminary assessment in which EMMI collected and used recent money market data (from September 2016 to February 2017) in order to evaluate the implications of moving away from a quote to transaction-based Euribor (Euro Interbank Offered Rate) methodology. Before this test period, EMMI based its proposed methodology on data from January 2012 to August 2013, which was considered not to be representative given the different levels in excess liquidity in the Eurosystem. In addition, during the trial phase the contribution and infrastructure of the new methodology were tested. According to EMMI, a seamless evolution to a transaction-based benchmark will ensure that Euribor stays fully representative of market conditions and that it results in a more robust and transparent benchmark. Furthermore, the results of the test phase will provide more clarity whether the new transaction based methodology will be implemented at the end of Q2, as it is currently planned.

The results will also give an answer to which extent under the new methodology the level of the Euribors fixings will differ, whether the fixings experience a higher level of volatility and how consistent the transaction based calculation methods are. Under the new methodology, Euribor should be more closely linked to observable transactions with eligible counterparties and security types. The new Euribor fixings should therefore follow the market levels of a broader range of money market securities, like commercial paper and certificates of deposits. Additionally, floating rate notes have been explicitly excluded to the list of eligible securities, however EMMI still decided to take transaction data of these securities into account in its Pre-Live Verification Program to evaluate the impact of the inclusion. Finally, the results will give guidance on the impact of including a larger group of eligible counterparties. Under the old methodology, only a panel of so called prime banks were asked to provide an interest rate at which they were willing to borrow uncollateralised from another bank. Under the new methodology, not only transactions between banks are included, but also with money market funds, official sector institutions, insurance companies, pension funds and non-financial corporations (irrespective of their geographic location). Given the broader range of eligible counterparties, the dispersion in rates could be wider than currently is the case. Particularly in periods of limited panel bank contributors and transaction volumes.

The general market consensus is that the new methodology will lead to somewhat lower Euribor fixings as now a broader range of eligible counterparties are included who are not being floored by the ECB’s deposit rate facility. Indeed, on the day preceding the announcement of the reform results, buying action in Euribor futures suggest that the market is expecting lower fixings going forward. Especially futures which concentrate on the second half of the year are suggesting somewhat lower fixings. The price action also suggests that EMMI is not expected to postpone the implementation of the new transaction-based methodology.  (Fouad Mehadi and Kim Liu)