Powell Keeps The Risk Rally Going

It felt as though markets spent all of last week waiting for the Jackson Hole symposium but in the event Federal Reserve Chair Powell didn’t really tell us anything new.  This was good enough for risk assets, with equities ending the week higher and bonds also rallying, with the US Treasury curve bull steepening, setting up a positive start for equity markets this week.  The US dollar came under pressure as Powell did not repeat the hawkish messages of some recent Fed speakers over recent days.

Overall Powell noted that one of the key criteria for tapering has been met, namely “substantial further progress” for inflation while “clear progress” has been met on the second goal of maximum employment. Powell also disassociated the criteria for rate hikes and tapering, with markets continuing to price in the first hike around March 2023. A tapering announcement is likely this year, but September looks too soon. 

The US dollar is likely to remain under pressure this week in the wake of Powell’s comments which ought to bode well for many emerging market currencies.  The potential for a softer than consensus US August jobs report (non-farm payrolls consensus 750k) at the end of the week also suggests that the USD could struggle to make a short term rebound though US interest rate markets, will likely remain supported. 

All of this bodes well for some consolidation in Asian markets though tomorrow’s Chinese August purchasing managers index (PMI) data will provide further direction.  Further moderation in both manufacturing and services PMIs will likely keep up the pressure on the authorities there to avoid renminbi appreciation as well as loosen liquidity likely via another reserve requirement ratio (RRR) cut. 

Other key data this week includes Q2 GDP releases in Australia (Wed), India (Tue), and Canada (Tue), US ISM surveys (Wed) and (Fri), Eurozone inflation data (Tue), and Polish inflation (Tue).  Also keep an eye on German political developments; the election is less than one month away and recent polling has shown that the SPD has pulled ahead of Merkel’s CDU for the first time in 15 years, raising the possibility of a left wing coalition. 

Geopolitical issues, specifically to do with Afghanistan remain a threat to risk appetite as the US deadline for evacuation approaches.  Separately, oil prices could be impacted by Hurricane Ida, which hit the US Gulf Coast yesterday.   

Two Speed Recovery

The spread of the COVID Delta variant globally holds key risks for markets in the weeks ahead.  However, as long as hospitalisation rates remain relatively low, it should be less detrimental to the path of re-opening in countries with higher vaccination rates.  As a stark example, the UK will shed almost all of its COVID restrictions today despite spiking COVID cases amid relatively low hospitalisation rates.  

This is particularly difficult for many emerging markets including much of Asia given low vaccination rates.  As such, a two-speed recovery between developed and emerging economies is occurring, with the former registering much higher vaccination rates compared to the latter.  Unlike the move to re-open in developed markets, re-opening in many emerging markets is far more difficult given sharply increasing hospitalisation rates among unvaccinated people as the Delta variant runs rampant. 

As such, the risks of renewed restrictions in many countries could put the global recovery process in jeopardy at a time when we are already past peak growth.  Maybe this is helping to dampen US bond yields or yields are being supressed by the fact that the market has a lot of faith in the Fed even as inflation has surprised on the upside in many countries.  Whatever the cause, US 10y bond yields have slipped below 1.3% back to levels not seen since mid-February and continue to edge lower.    

Event highlights this week include several central bank policy decisions including in China (Tue), Eurozone, Indonesia, South Africa (all Wed) and Russia (Fri).  No changes are expected for China’s Loan Prime Rate (LPR) though the risk of easing has increased marginally following the People’s Bank of China (PBoC) reserve requirements (RRR) cut last week. The Central Bank of Russia (CBR) is expected to hike by 75bp, with risks of a bigger move.  Bank Indonesia is likely to remain on hold despite growing economic pressure.  South Africa’s Reserve Bank (SARB) is expected to remain on hold and remain dovish while a change in forward guidance from the European Central Bank (ECB) is expected this week. 

Oil will be in focus today after OPEC+ agreed on a deal to expand output, with the UAE and Saudi Arabia putting away differences to agree upon a 400k barrels a day increase in output from August.  The US dollar (USD) is trading firmer, but overall looks like it is close to topping out.  For example, EURUSD looks oversold relative to real rate differentials.  Interest rates markets will eye US fiscal developments, with Democrats crafting the budget resolution needed for a reconciliation bill, which may see additional progress this week.

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