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. 

Plethora Of Central Banks

This week is a busy one for central bank meetings and data releases.  There are key policy meetings in the US (Wed), followed by Indonesia, Norway, Switzerland, Turkey, Brazil (all on Thu) and Japan (Fri).  None are expected to change policy settings except the BCB in Brazil, with the consensus expecting a 75bp hike there.

There will however, be lot of attention on the language of the statements for any hawkish tinges.  The US Federal Reserve FOMC for instance is likely to continue to highlight that inflation pressures are transitory but could state they have started to discuss some form of progress-dependent tapering plan even as the Fed remains far from actual tapering. 

While markets may be buying the “transitory” inflation story, consumer expectations remain elevated.  The New York Fed survey showed that consumer inflation expectations 3 years out rose to an 8 year high of 3.6% in May while 1-year expectations rose to a record 4%.  However, markets may find some solace from the drop in lumber prices, which have dropped by around 40% since early May though the CRB commodities index remains near multi-year highs.   

Norway’s Norges Bank may start preparing markets for a third quarter rate hike.  In contrast, in Turkey, attention will be on any clues to when the central bank will ease policy amid calls for a cut from President Erdogan. The Bank of Japan is likely to extend COVID aid for businesses while Bank Indonesia is likely to focus on transmission of past easing rather than cut again. 

Key data this week includes US May retail sales (today) for which a monthly decline in headline sales is likely though spending is still likely to have grown strongly over the quarter.  China’s May data dump (Wed) will also garner attention, with healthy gains in both retail sales and industrial production likely, even taking account of base effects. 

Australia’s May jobs report (Thu) is forecast to show an increase though there are downside risks emanating from JobkKeeper’s expiry in May.  Reserve Bank of Australia June minutes (today) and speech by governor Lowe (Thu) will also be scrutinized for thinking on whether RBA will extend the YCC bond to the Nov 24s and quantitative easing commitment. 

There are also several other central bank speeches of importance this week including two speeches by Bank of England governor Bailey, and several European Central Bank speakers. 

Turkey, Emerging Market Central Banks, Eurozone Divergence

Attention today is on developments in Turkey. Despite consensus expectations of a 100bp (1%) hike in rates, Turkey’s central bank delivered a bigger than expected 200bp increase last week, with a hawkish statement.  This appears not have been welcomed by Turkish President Erdogan who promptly removed central bank (CBRT) Governor Aqbal on Saturday.  Despite some reassurance from Aqbal’s replacement that policy would deliver price stability the result has been substantial pressure on Turkey’s currency the lira (TRY) at the start of trading in Asia today, with the lira down as much as 15% initially, erasing more than four months of gains.  Turkish authorities are likely to intervene to limit the damage, but the damage has been done.  There has also been some, albeit more limited fall out on other emerging market currencies.

The end of the week saw a bit of a reversal in recent trends, with tech stocks gaining most, at the expense of bank stocks, which were weighed down by the news that the US Federal Reserve would not extend the Supplementary Leverage Ratio (SLR) exemption but rather to look at a more permanent solution. This could lower banks demand for Treasuries while constraining dealer balance sheets. Both S&P 500 and Nasdaq recorded declines over the week amid a further rise in US Treasury yields.  Quadruple witching saw an increase in volumes and oil prices recorded a sharp close to 8% decline over the week while Chinese stocks continued to suffer. 

Aside from Turkey there was some interesting central bank action last week in the emerging markets.  The BCB in Brazil hiked by 75bps, more expected, and indicated the high likelihood of another 75bps at the May meeting.  The CBR in Russia also joined in on the hawkish emerging markets (EM) action surprising markets by hiking rates by 25bps, with a likely acceleration in tightening likely over coming meetings.  EM central bank decisions this week include China (today), Philippines (Thu), Thailand (Wed), Hungary (Tue), South Africa (Thu), Mexico (Fri) and Colombia (Fri).   Separately, the SNB in Switzerland also decides on policy (Thu). China’s loan prime rates were left unchanged as expected and no changes are likely from any of the other central banks this week. 

Other data and events this week include the US PCE report (Fri), President Biden’s press conference (Thu) which could offer clues to the “Rescue” package that could amount to $3-4trn. A host of Fed speakers are also on tap, including Fed Chair Powell, as well as Eurozone flash purchasing managers indices (PMIs) (Wed), and UK retail sales (Fri).  The data will reveal stark differences in the recovery picture in the UK and Eurozone while the difference between the US and Europe looks even more stark.  Europe is struggling with a third wave of Covid case, vaccination delays and tighter restrictions, leading to a reduction in growth forecasts, while US growth forecasts are being revised higher in the wake of the $1.9tn stimulus package. This will likely result in some underperformance of Eurozone markets relative to the US.  

Will the Fed Calm US Treasury Market Volatility?

The main market action on Friday was once again in US Treasuries, with another sharp sell off as the 10y yield spiked 8.8 basis points despite three large US debt auctions over the week that were received relatively well by the market.  The sell-off helped the US dollar (USD) to strengthen while oil prices slipped. USD sentiment is clearly becoming less negative as reflected in the latest CFTC IMM data (non-commercial speculative market positioning), which shows that USD (DXY) positions (as a % of open interest) are still short, but at their highest since the week of 8 Dec 2020. Tech stocks didn’t take well to higher yields, but the Dow and S&P 500 closed higher. The move in yields may pressure Asian currencies and bond markets after some consolidation/retracement towards the end of last week though equity markets look better placed. 

At the end of last week US University of Michigan consumer sentiment rose to 83.0 in the preliminary release for March from 76.8 in February and exceeded expectations at 78.5 (consensus). This week attention will turn to a plethora of central banks spearheaded by the Federal Reserve FOMC (Wed). Markets will be watching for any revisions to US growth forecasts amid a dovish tone, albeit with little sign of any push back on higher yields. US rates markets will also focus on the US 20y auction, which could keep the curve pressured steeper.  Nervousness over the Statutory Liquidity Ratio (SLR) exemption, which is set to expire at the end of the month, will also likely intensify.  A less dovish than hoped for Fed, will likely keep the USD on the front foot. 

Other central bank decisions this week will take place in the UK, Norway, Turkey, Russia, Indonesia, Taiwan, Brazil and Japan. None of these are likely change policy settings except Brazil, where the market is looking for a 1/2% hike. Developments to look out for include some push back from the Bank of England on higher yields, a move to bring forward the rate hike path in Norway, a potentially controversial no change decision in Turkey and the Bank of Japan’s announcement of the results of its policy tools and in particular clarification on the tolerated trading range for 10-year JGBs.

Data this week kicks off with Chinese activity data today including February industrial production and retail sales. Seasonal distortions and base effects will make this month’s data look particularly strong.  Other data this week includes US Feb retail sales (tomorrow) where a weak outcome is likely depressed by harsher-than-usual winter weather as well as a fading of the boost from stimulus payments. Australia February employment is also likely to be soft (Thursday).  

Overall, equity volatility has eased, especially in the equity market, suggesting some return of normal trading conditions there, but interest rate volatility remains high driven by the move in US Treasury yields.  The USD gave back some gains towards the end of last week, but will likely benefit from higher US yields and is set to start this week in firm form.  US interest rate gyrations will likely provide further direction for the USD over the rest of the week.   Much of course will depend on the Fed FOMC meeting, which will be the main event this week. 

Host Of Central Banks In Focus

Well, last week, tech stocks had their worst week since March, with stability far from returning.  While the jury is still out, most still view the pull back in tech stocks as a healthy correction following a prolonged period of gains, blaming increased options activity over recent months for the magnitude of the decline. The buy on dip mentality is likely to continue to prevail, though tech stocks have not yet show any sign of wanting to make a convincing pull back.   

Signs of nervousness are clear; equity volatility remains elevated, but many investors are still sitting on healthy gains over recent months.  Given the low cost of funding, low returns in government bonds, alongside continued strong demand for stay at home electronics and a vaccine that could still take months to arrive, it is hard to see the tech sector falling too far.   

The fall in the pound sterling has been quite dramatic over recent weeks, both against the US dollar and euro.  Fears over a collapse in trade talks with the European Union have intensified.  The sudden waking up of the market to these risks has been provoked by the prospects that the withdrawal agreement with the EU will be torn up, prompting threats of legal action by the EU.

Time is running out to get a deal on the table before the end of the Brexit transition period at the end of the year, but UK Prime Minister Johnson has said that the internal market bill is necessary to prevent “a foreign of international body from having the power to break up our country.” The new legislation is already facing a rebellion in parliament. Against this background its hard to see GBP rally, with the currency likely to be particularly volatile over the coming weeks.

Attention this week will turn to several central bank decisions, with monetary policy makers in Poland (Tue), US (Wed), Brazil (Wed), Japan (Thu), Indonesia (Thu), Taiwan (Thu), South Africa, (Thu), UK (Thu) and Russia (Fri) all scheduled to announce their decisions.  After months of policy easing globally, this week will look rather boring, with none of the above likely to ease further.   

The Fed FOMC meeting will likely capture most attention, but there is potential for disappointment if the Fed does not provide further details on its shift to average inflation targeting in its forward guidance, even as the accompanying statement and Chair Powell’s press conference are likely to sound dovish. The US dollar has continued to stabilize, aided by the drop in GBP, but a dovish Fed could limit further upside in the short term. 

Aside from central bank decisions attention will be on US election polls, which take on more importance as the election creeps closer.  US fiscal stimulus talks have hit a wall, with little chance of progress this week, while US pressure on China and Chinese companies is likely to continue to be unrelenting as elections approach.  On the political front the race to take over Japan’s prime minister following the resignation of Shinzo Abe will conclude this week (Wed).   

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