Busy Week Ahead For Central Banks

US equities came under more pressure at the end of last week, with the S&P 500 falling to its lowest in four weeks, down around 2% month to data.  The drop will test the buy on dips mentality as the S&P is once again resting just above its pivotal 55-day moving average, a level that has seen strong buying interest in the past. 

Economic data gave little help to market sentiment, with the University of Michigan confidence index improving a little to 71.0 in early September but falling slightly below consensus expectations at 72.0.  Separately, the inflation expectations measures were broadly unchanged, with the most relevant series for Fed officials (the 5-10y) remaining steady at 2.9%, which is still consistent with the Fed’s 2% goal.

This week is all about central bank meetings, with an array of policy meetings including in Indonesia (Tue), Sweden (Tue), Hungary (Tue), China (Wed), Japan (Wed), US (Wed), Brazil (Thu), Philippines (Thu), UK (Thu), Norway (Thu), Switzerland (Thu), South Africa (Thu), and Taiwan (Fri), all on tap. 

Most focus will obviously be on the Federal Reserve FOMC meeting, during which officials will likely signal that they are almost ready to taper. A formal announcement is likely in December or possibly November.  Most other central banks are likely to stay on hold except a likely 25bp hike in Norway, 25bp in Hungary, and 100bp in Brazil.

Politics will also be in focus, with Canada’s Federal election and the results of Russia’s parliamentary elections today.  Polls suggest the incumbent Liberals ahead though the most likely outcome is a minority government in Canada while in Russia the ruling pro Kremlin United Russia party is likely to renew its supermajority. 

Other issues in focus this week are frictions over the US debt ceiling, with the House voting soon on raising the ceiling.  US Treasury Secretary Yellen renewed her calls for Congress to raise of suspend the debt ceiling stating in a Wall Street Journal op-ed that failing to do so “would produce widespread economic catastrophe”. 

In China, Evergrande’s travails will be in the spotlight on Thursday when interest payments on two of its notes come due amid growing default risks.  Indeed, China related stocks slid on Monday morning as Evergrande concerns spread through the market.  Property developer stocks are under most pressure and whether there is wider contagion will depend on events on Thursday.

The US dollar has continued to strengthen, edging towards its 20 Aug high around 92.729 (DXY) and looks likely to remain firm heading into the Fed FOMC meeting especially as it will hard for Fed Chair Powell to sound too dovish and given risks of a hawkish shift in the dot plot.  Positioning data is showing increasingly positive sentiment towards the dollar, with speculative positioning (CFTC IMM net non-commercial futures) data showing the highest net long DXY position since May 2020. 

Conversely, speculative positioning in Australian dollar has hit a record low likely undermined by weaker iron ore prices.  Similarly, positioning in Canadian dollar is at its lowest since Dec 2020 while Swiss franc positioning is at its lowest since Dec 2019. Asian currencies have been hit, with the ADXY sliding over recent days.  The Chinese currency, CNY has been undermined by weaker data and concerns over Evergrande while high virus cases in some countries are hurting the likes of Thai baht. 

Market Cross-Currents

There are many cross currents afflicting markets at present.  Equity valuations look high but US earnings have been strong so far, with close to 90% of S&P 500 earnings coming in above expectations. This has helped to buoy equity markets despite concerns over the spreading of the Delta COVID variant and its negative impact on recovery.  Yet the market doesn’t appear entirely convinced on the recovery trade, with small caps continuing to lag mega caps. 

The USD index (DXY) remained supported at the end of last week even as US yields remain capped, but the USD does appear to be losing momentum. Positioning has now turned long according to the CFTC IMM data indicating that the short covering rally is largely exhausted; aggregate net USD positioning vs. major currencies (EUR, JPY, GBP, AUD, NZD, CAD & CHF as a percent of open interest) turned positive for the first time in over a year. 

Inflation fears have not dissipated especially after recent above consensus consumer price index (CPI) readings, for example in the US and UK.  Reflecting such uncertainty, interest rate market volatility remains high as seen in the ICE BofA MOVE index while inflation gauges such as 5y5y swaps have pushed higher in July.  There was some better news on the inflationary front at the end of last week, with the Markit US July purchasing managers indices (PMIs) revealing an easing in both input and selling prices for a second straight month, albeit remaining at an elevated level. 

This week we will get more information on inflation trends, with the June Personal Consumption Expenditures (PCE) report in the US (Fri), Eurozone July CPI (Fri), Australia Q2 CPI (Wed) and Canada June CPI (Wed), on tap this week.  We will also get to see whether the Fed is more concerned about inflation risks at the Federal Open Markets Committee (FOMC) meeting (Wed).  The Fed is likely to continue to downplay the surge in inflation, arguing that it is transitory, while the standard of “substantial further progress” remains a “ways off”.   Nonetheless, it may not be long before the Fed is more explicit in announcing that is formally moving towards tapering. 

An emerging markets central bank policy decision in focus this week is the National Bank of Hungary (NBH) where a 15bp hike in the base rate is expected.  Central banks in emerging markets are taking differing stances, with for example Russia hiking interest rates by 100 basis points at the end of the week while China left its Loan Prime Rate unchanged.  The July German IFO business climate survey later today will be in focus too (consensus 102.5).  Overall, amid thinner summer trading conditions market activity is likely to be light this week.

Lots Of Buyers On Dips

Last week’s bout of risk-aversion proved short-lived though more volatility likes lies ahead. The reflation trade looked like it was falling apart last week as reflected in the sharp decline in US Treasury bond yields and the shift out of value into big tech/growth stocks.  The markets appeared to have increasingly absorbed the Fed’s message that inflation increases will be transitory while a reversal of crowded market positioning in reflation trades exacerbated the moves.  The malaise in markets coincided with several indicators revealing peak growth has passed and the rapid spread of the Delta variant globally.

However, clearly that didn’t appear to be the case by the end of last week as equities rallied strongly and the US Treasury curve shifted higher.  The US dollar gave up some of its gains while oil and gold rallied.  While there are still concerns about peak growth passing and the rapid spread of the Delta variant, there are obviously still plenty of buyers willing to jump in on dips. 

China’s central bank, PBoC went ahead with a much anticipated reserve requirement ratio cut sooner than expected on Friday though this targeted liquidity easing is unlikely to change the fact that growth is losing momentum amid a weakening credit impulse.  This week, key events include China’s June trade data (Tue) for which outsized gains in exports and imports is likely.  China’s monetary and credit aggregates will also be out sometime over the week as well as Q2 GDP and the June data dump, with some further moderation likely to be revealed. 

Top US data includes June CPI inflation (Tue) and retail sales (Fri).  CPI is likely to record another sizeable 4.9% y/y increase though the Fed’s repeated message of transitory inflation, will limit any market concerns over inflation pressures.  Also given the gyrations in markets last week, there will be even more focus on Federal Reserve Chair Powell’s semi-annual testimony to Congress (Wed & Thu).  The start of the Q2 earnings season will also come under scrutiny, with expectations of a 63% surge forecast according to FactSet data.   

Monetary policy rate decisions in New Zealand, Canada, Turkey (all on Wed), Korea (Thu) and Japan (Fri) are on tap, with the former two likely to reveal upbeat views while the CBRT in Turkey will have limited room to ease given the recent spike in inflation.  BoK in Korea may dial back a little of its hawkish rhetoric giving increasing virus cases in the country, while BoJ in Japan is likely to revise higher its inflation forecasts but leave its economic outlook unchanged.  Australian and UK jobs data (Thu) will also garner attention. 

What Could Prompt Higher Volatility?

Equities were buoyed last week in the wake of US President Biden’s infrastructure deal and renewed reflation trade optimism amid mixed post Federal Reserve FOMC messages from Fed officials. This resulted in US stocks recording their biggest weekly gain since February.  The prospects of passing the infrastructure deal has improved in the wake of Biden’s decision not to tie it to a much larger spending package that is being pushed through by Democrats but is not supported by Republicans. 

Given heightened sensitivity over inflation, the slightly weaker than expected US Personal Consumption Expenditures (PCE) data on Friday, which increased 0.5% m/m in May, slightly below the 0.6% consensus, added further support to the reflation trade, helping the US Treasury curve to steepen.  Moreover, the University of Michigan 5-10y inflation expectations series came in lower in June compared to the previous month. Fed officials likely put much more emphasis on this long-term series and will view the 2.8% reading as consistent with their “largely transitory” take on the pickup in inflation.

Cross-asset volatility has continued to decline, which bodes well for carry trades and risk assets.  For example, the VIX “fear gauge” index has dropped to pre-COVID level, something that has been echoed in other market volatility measures.  However, it’s hard to ignore the shift in tone from many central banks globally to a more hawkish one while risk asset momentum will likely wane as the strength of recovery slows, suggesting that low volatility may not persist.  It is notable that changes in global excess liquidity and China’s credit impulse have both weakened, implying a downdraft for risk assets and commodity prices and higher volatility. 

If there is anything that could prompt any increase in volatility this week, its the US June jobs report on Friday.  June likely saw another strong (consensus 700k) increase in nonfarm payrolls while the unemployment rate likely dropped to 5.7% from 5.8% previously.  Despite the likely strong gain in hiring, payrolls would still be close to 7 million lower compared to pre-COVID levels, suggesting a long way to go before the US jobs market normalises. The June US Institute for Supply Management (ISM) manufacturing index will also come under scrutiny though little change is expected from the May reading, with a 61.0 outcome likely from 61.2 in May. 

Other data and events of importance this week include the 100th year anniversary of China’s Communist Party (Thu), the release of purchasing managers indices (PMI) data globally including China’s official NBS PMI (Wed) for which a slight moderation is expected.  Eurozone June CPI inflation (Wed) which is likely to edge lower, Sweden’s Riksbank policy decision (Thu) where an unchanged outcome is likely and Bank of England (BoE) Governor Bailey’s Mansion House Speech (Thu), will be among the other key events in focus this week. 

When Bad Means Good

Bad meant good on Friday as weaker than expected US April jobs data helped to dampen concerns over inflation risks and higher rates. At a time when markets were becoming increasingly fearful of rising inflation risks the softer US jobs data will act as a balm on such fears. It also complicates matters ahead of bipartisan talks between President Biden and congressional leaders this week. Democrats will likely use the data to outline their case for more stimulus to boost growth, while Republicans will highlight that excessive unemployment benefits are holding back hiring.  

US Payrolls increased by 266,000 in April, well below the 1 million consensus and the unemployment rate rose to 6.1% from 6.0%, above the 5.8% consensus.  The data supports the view of most Fed officials that progress has not been “substantial” enough for them to start signaling tapering.  Unsurprisingly Markets pushed back the pricing of the first rate hike from early-2023 to May 2023 in the wake of the weaker US jobs data. The US dollar (USD) took a hit and looks likely to kick off the week on the back foot.  High yielding currencies will likely benefit the most.  

This week inflation releases will come under scrutiny, with CPI data in the US (Wed), China (Tue) and India (Wed) in focus, albeit for different reasons.  In the US, base effects will likely push inflation higher, with a sharp pick up in core CPI in particular likely.  A similar story is expected in China, but base effects will likely act in the opposite direction in India.  Other highlights this week include a likely modest decline in US retail sales (Fri), further easing in China’s credit aggregates (9-15 May) and a material improvement expected to be revealed in Australia’s Federal Budget (Tue).  Last but not least, central banks in Mexico and Philippines (both Thu) are expected to leave policy unchanged.

Separately, markets will digest the outcome of UK local elections, especially those in Scotland, which revealed that pro-independence parties (SNP and Scottish Greens) gained a majority in the Scottish parliament. A constitutional battle with the Conservative UK government looms though UK Prime Minister Boris Johnson is showing no signs of acceding to demands for a new Scottish referendum.  There will also be focus on the aftermath of the ransomware attack on the Colonial Pipeline in the US, which has already pushed energy prices higher.  And finally, the much anticipated (among Krypto traders) appearance of Elon Musk on SNL hit Dodgecoin, after he called it “a hustle”. 

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