BRUSSELS (Reuters) - The guessing game over U.S. interest rates is likely to intensify this week after new Fed Chair Janet Yellen raised the prospect of a hike early next year, while Russia’s annexation of Crimea will keep investors focused on its next move.
In a week heavy with diplomacy - U.S. President Barack Obama will meet Chinese counterpart Xi Jinping on Monday in The Hague - markets will seek clarity from the U.S. Federal Reserve on its monetary policy and from Russia over its intentions in Ukraine.
While the U.S. data calendar is relatively light, Yellen has got investors talking by suggesting interest rates could start rising next spring, compared with most economists’ expectations for the second half of 2015.
The question is whether the host of Fed policymakers due to speak this week, including the Fed’s Chicago President Charles Evans, will try to distance themselves from Yellen.
“We have to consider the possibility of the first rate hike coming in April 2015,” said James Knightley at ING in London. “Market pricing is still favoring the third quarter of 2015, but a decent rise in employment and business activity may see this change,” he said.
Last week the Fed, in its first policy-setting meeting under Yellen, said it would factor in a wide range of economic measures as it judged the correct timing for raising rates.
Investors are wondering how much of the slowdown in the U.S. economy this winter was due to bad weather. Data this week may not clear up that uncertainty because home sales, goods orders and consumption data will be from February, rather than March.
Still, a Reuters survey of economists shows that Yellen’s comments have not altered their views. Ten dealers of 17 polled see rate hikes in the second half of 2015, with another four saying increases would not start until 2016.
That suggests a normalization of U.S. interest rate policy has yet to be factored into the U.S. dollar exchange rates versus the yen and the euro, economists say.
“We can only conclude that despite all the Fed’s forward guidance and efforts to improve its communication, the Fed’s probable course of action is not fully priced into dollar exchange rates,” said Ulrich Leuchtmann at Commerzbank.
“A phase of serious dollar strength will only set in later in the year. But then it will do so with a vengeance,” he said.
International diplomacy will be dominated by the response to Russia’s annexation of Crimea. Leaders of the world’s leading industrial democracies will hold a Group of Seven meeting without Russia on the sidelines of a nuclear security summit in The Hague this week to consider further responses to the crisis.
Russian markets ended last week by taking fright at a U.S. decision to slap sanctions on Russian President Vladimir Putin’s inner circle of money men and security officials. Finance Minister Anton Siluanov said Russia might cancel its foreign borrowing for 2014, though it has enough foreign reserves and a low enough budget deficit to be able to put off borrowing plans.
Russian stocks may be in for an easier ride if investors have a sense that the stand-off with the West is not intensifying for now, even though big risks remain.
Given that U.S. sanctions targeting Russian elites were stronger than anticipated and that EU leaders added more names to their list, retaliation from Russia cannot be ruled out.
“While the situation remains tense, it likely remains stable in the coming weeks,” said Mujtaba Rahman, a political analyst at Eurasia Group. “Wildcards include the possibility of a flare-up of Ukrainian versus Russian violence in eastern Ukraine, which would heighten the possibility of Russian invasion.”
Difficult as it may be to look beyond Russia, China’s release on Monday of the HSBC flash manufacturing purchasing managers index (PMI) will be arguably the most watched release in Asia, as investors question how the Chinese economy has fared in the first quarter.
“The February round of data pointed to the weakest growth momentum since the global financial crisis,” said Mole Hau at BNP Paribas, referring to the recent slump in investment, retail sales and factory output.
Chinese Premier Li Keqiang has said the economy faced “severe challenges” in 2014. Bank of America Merrill Lynch has cut its first-quarter growth forecast to 7.3 percent from 8.0.
A week before the European Central Bank’s (ECB) monetary policy meeting on April 3, President Mario Draghi has investors wondering what it will take for him to counter the very low rate of inflation in the euro zone.
Draghi will speak in Paris on Tuesday to try to drive the message home that the ECB will stick to its very accommodative policy stance for a long time, not raising rates even if inflation picks up.
Draghi has said the ECB would keep a close eye on the euro exchange rate, one of the key parameters affecting inflation that is at a four-year low. The Fed’s rate hike talk has taken some steam out of the euro’s rise, though that might not last.
A string of euro zone PMIs will also give a sense of the bloc’s recovery, with many economists expecting a slight increase in the euro area composite PMI, driven by a modest rebound in the manufacturing sector.
Economists expect French PMIs to improve, while in Germany better manufacturing surveys could compensate for last month’s weakness. “The gradual recovery continues,” Citi economists said in a note to clients. “We still expect the ECB to cut rates in June but the window seems to be narrowing gradually.”
Editing by Mark Potter